Financial Analysis of Diageo PLC

Cluster 1

Michael Calo, Yannick Gielis, Maxim Mommerency, Ying Tian, Arthur Vanhove

ii

Diageo | Cluster 1 | Rémy Cointreau

iii

1. TABLE OF CONTENTS

1. TABLE OF CONTENTS ..................................................................................................... iii

2. INTRODUCTION ................................................................................................................. 1

2.1. Diageo PLC ................................................................................................................................................ 1 2.2. Company Structure ................................................................................................................................ 1 2.3. Environment ............................................................................................................................................ 2

3. CLUSTER 1: BENCHMARK ANALYSIS .......................................................................... 4

3.1. Profitability Ratio’s ............................................................................................................................... 4 3.1.1. Net Profit Margin ........................................................................................................................................... 5 3.1.2. Gross Operating Margin ............................................................................................................................. 6 3.1.3. Net Operating Margin .................................................................................................................................. 7 3.1.4. Return on Equity ........................................................................................................................................... 8 3.1.5. Return on Assets ............................................................................................................................................ 9 3.1.6. Earnings per Share ..................................................................................................................................... 10

3.2. Asset Utilization Ratios ..................................................................................................................... 11 3.2.1. Total Asset Turnover ................................................................................................................................. 11 3.2.2. Long-Term Asset Turnover .................................................................................................................... 13 3.2.3. Inventory Turnover ................................................................................................................................... 15 3.2.4. Receivables Turnover ............................................................................................................................... 16

3.3. DuPont Analysis ................................................................................................................................... 17 3.3.1. Profit Margin ................................................................................................................................................. 19 3.3.2. Asset Turnover ............................................................................................................................................. 20 3.3.3. Equity Multiplier ......................................................................................................................................... 22

3.4. Capital Market Analysis .................................................................................................................... 23 3.4.1. Price-to-Earnings Ratio ............................................................................................................................ 23 3.4.2. Dividend Yield Ratio .................................................................................................................................. 24 3.4.3. Market Analysis ........................................................................................................................................... 24

4. CONCLUSIONS AND RECOMMENDATIONS ............................................................. 28

4.1. Conclusions............................................................................................................................................ 28 4.2. Recommendations .............................................................................................................................. 30

5. REFERENCES .................................................................................................................... 31

1

2. INTRODUCTION

The financial analysis of Diageo is comprised of two clusters. This analysis covers cluster 1

and talks about profitability ratio’s, asset utilization ratio’s, DuPont analysis and capital

market analysis. After the initial calculations, we critically interpreted the numbers and

penned down our considerations. We would like to note that all numbers are in UK Pound

(£) unless otherwise stated.

We continue the introduction with a short introduction to the company Diageo, its

structure and its competitive environment. In chapter 3, we analyze profitability, asset

utilization, DuPont and Diageo’s capital market position. Chapter 4 will cover our

conclusions and recommendations.

2.1. Diageo PLC

Diageo is a global leader in the alcoholic beverage industry, whose portfolio includes

some emblematic brands in beer, spirits and wine. According to the company, wants to

stand out through transparency, authenticity and good citizenship. In terms of values,

Diageo is innovative, flexible, and ambitious and puts emphasis on internal and external

respect.

While Diageo has only existed since 1997 in its current form through the merger of Grand

Metropolitan PLC and Guinness PLC, their brands have a rich and compelling history:

some of the Diageo brands are as old as 1749 (J&B) and 1759 (Guinness). The company

decided to strategically reform between 2000 and 2002 by focusing on the alcoholic

beverage markets, selling its food assets such as BurgerKing in the process.

2.2. Company Structure

The company’s strengths lie in its global reach. As a consequence, Diageo has a relatively

straightforward divisional structure based on geography. The company includes 21

markets spread over five main regions:

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Diageo North America (US Spirits & Wines, Guinness USA, and Canada);

Diageo Europe (Western & Eastern Europe, Russia, and Turkey);

Diageo Africa (Nigeria, East Africa, Regional Markets, and South Africa);

Diageo Latin America and Caribbean (Paraguay, Uruguay & Brazil, Venezuela,

Colombia, Mexico, and West LAC);

Diageo Asia Pacific (South East Asia, Greater China, India, Global Travel, Middle East,

Australia, and North Asia).

Key figures of Diageo include dr. Franz B. Humer (chairman) and Ivan Menezes (CEO).

Figure 1 - Diageo's Five Regions (http://www.diageo.com)

Furthermore, in order to stay ahead of the competition in terms of innovations and to

support entrepreneurial mindsets, Diageo is organizing technology ventures for

innovative technology start-ups and entrepreneurs. As a mutual benefit, the company

hopes to get a long-term strategic partnership with the winning application.

As a leading global company, Diageo has managed to get international recognition. It’s

featured in Fortune’s ‘25 Best Global Companies to Work For’ as #11 in 2011, #9 in 2012,

#8 in 2013, and #20 in 2014. Besides, it was #6 ‘Most Admired Company’ of 2012. In

Forbes’ Global 2000 ‘World Biggest Public Companies’, it was recently ranked #245.

2.3. Environment

The alcoholic beverage market is a historical one, and as such it features many strong and

iconic brand names with a strong heritage. As stated above, Diageo is a mayor player in

the alcoholic beverages industry. Within this industry, its main competitors include AB

InBev, Heineken, Carlsberg (beer), the Absolut Company, Bacardi, Pernod Ricard and

Rémy Cointreau (spirits and/or wines). If we look to the much broader beverage industry,

we can include companies showcasing products like water, soft drinks, coffee and tea as

3

competitors, albeit less directly and as a substitute product. For the purpose of this study,

we will focus on Rémy Cointreau as a benchmark competitor.

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3. CLUSTER 1: BENCHMARK ANALYSIS

3.1. Profitability Ratio’s

Table 1 – Asset Utilization Ratios for Diageo

One of the key objectives of a company is to profit from company activities. For that

purpose, profitability ratios are ideal for measuring the success of a company. The

company as well as potential investors will look at these numbers to assess company

profitability. A company could have fantastic management, a conservative capital

structure, and great products, but if it does not produce a profit, the company will not

remain in business and investors won’t participate. The following ratios have been

measured and analysed: net profit margin, gross profit margin, net operating margin,

return on equity, return on assets, and earnings per share. These ratios are analysed in

comparison to competitors or compared to the ratios in previous periods. The calculated

ratios will be compared and evaluated with a benchmark company, Rémy Cointreau. The

profitability ratios of the last four years, 2011-2014, of Diageo are presented in table 2.

Asset Utilization Ratios DIAGEO

2011 2012 2013 2014

Total Asset Turnover .50 .48 .45 .45

Long Term Asset Turnover .78 .70 .69 .66

Inventory Turnover 1.14 1.06 1.05 .95

Receivable Turnover 6.54 6.08 5.59 5.12

5

DIAGEO REMY COINTREAU

Profitability

ratios

2011 2012 2013 2014 2011 2012 2013 2014

Net profit

margin

19.98 19.00 22.56 21.26 7.78 10.83 10.93 6.05

Gross profit

margin

59.75 60.45 60.93 60.72 57.09 61.40 61.75 59.93

Net operating

margin

26.01 29.21 29.90 26.39 13.27 19.95 19.94 14.08

Return on equity 32.89 29.76 31.53 28.74 6.64 11.38 11.91 6.17

Return on assets 14.59 15.43 14.92 13.05 6.53 11.57 11.08 7.08

Earnings per

share (£)

0.82 0.93 1.03 0.95 1.44 2.25 2.69 1.27

Table 2 - Profitability Ratio's for Diageo and Rémy Cointreau (%)

3.1.1. Net Profit Margin

Net profit margin is a ratio that informs you how much pound is left of each sale after all

of the expenses have been paid. It is the easiest way to see if your business was

successful: a higher net profit margin means that the company is more efficient at

converting sales into actual profit. It is calculated by dividing ( 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 −

𝑛𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒) by the total revenue of sales.

6

Graph 1: Net profit margin of Diageo & Rémy Cointreau (2011-2014)

The net profit margin of Diageo is highest in 2013, which is mainly due the sales of 2013

are more than a billion higher than in 2012 and approximately 1.4 billion higher than in

2014. The reason that the ratio of 2012 is lower than 2014, although the sales of 2012

were higher, is due the exceptional taxation (£ 505 million). This exceptional taxation was

found as: loss of future tax amortization, on some of its principal brands and other

intangible assets. Compared to the benchmark company, Rémy Cointreau, Diageo has a

clearly higher ratio. Sales of Rémy Cointreau are much lower, around factor 10 in 2014.

The main difference regarding net profit ratio between the two companies lies in the

amount of tax they have to pay. Rémy Cointreau’s profit is around 50% of the profit

before tax, as the net profit of Diageo is 82% of the profit before tax.

3.1.2. Gross Operating Margin

Gross operating margin is a perfect ratio to see how much a company earns, taking into

consideration the costs that go along with the production of the products and services.

Gross profit is a good indicator to represent the profitability on the most fundamental

level. It shows how efficient the company uses its materials, resources, labor,

manufacturing process and distribution. The ratio measures how well the company

controls its costs. The ratio is calculated by dividing the gross profit

(𝑠𝑎𝑙𝑒𝑠 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 – 𝑐𝑜𝑠𝑡𝑠 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑) by the sales revenue. The higher the percentage, the

more the company retains on each pound of sales, the better the company controls costs.

Investors compare this ratio to see which company is the most efficient.

0,00%

5,00%

10,00%

15,00%

20,00%

25,00%

2011 2012 2013 2014

Net profit margin

Diageo

Remy Cointreau

7

Graph 2: Gross profit margin of Diageo & Rémy Cointreau (2011-2014)

The gross profit margin of Diageo is more or less the same over this four-year period,

around 60%. This means that Diageo’s cost of goods sold is around 40% and that there

are around 60% of the sales left to pay operating costs and taxes. Compared with its

benchmark, Diageo had a stable ratio. Rémy Cointreau’s gross profit margin rose 3%

between 2011 and 2014, and is now also around the 60%. The main reason compared to

2011 is that the sales of Rémy Cointreau rose around €100 million, but the cost of sales

remained the same. Both companies are working about as efficient in 2014.

3.1.3. Net Operating Margin

This ratio is also a number that shows the efficiency of a company, it is similar to net

profit margin. The main difference is that the operating profit does not include taxes and

is in this context the same as earnings before interest and taxes. This ratio, which is also

called return on sales, is calculated by dividing the operating profit by the sales revenue.

The higher the number, the more efficient a business of a company is and the more

profitable.

54,00%

56,00%

58,00%

60,00%

62,00%

64,00%

2011 2012 2013 2014

Gross profit margin

Diageo

Remy Cointreau

8

Graph 3: Net operating margin Diageo & Rémy Cointreau (2011-2014)

The net operating margin of Diageo was in 2011 around 26% and got almost to 30% in

2013. This was because the operating profit was £828 million less in 2011, mainly due

almost 1.5 billion less in sales. Afterwards it dropped back to 26.4% in 2014, again

because sale dropped 1 billion that year. The trend was for Rémy Cointreau has almost an

identical curve on Graph 3. Still, there is a difference of around 12%. This difference is

caused because the distribution and adminstration costs are counting for more than 75%

of the gross profit at Rémy Cointreau. The operating costs and marketing count for

Diageo is around 56%. So out of each pound of sales there is £0.26 operating earnings at

Diageo and only £0.14 at Rémy Cointreau in 2014.

3.1.4. Return on Equity

Return on equity is more than an indicator of profit, it also indicates the efficiency of a

company. A rising return on equity means that a company may generate the same

amount of profit using less capital. Return on equity is the amount of net profit returned

as a percentage of shareholder’s equity: it gives an indication of how good the

management is using the shareholder’s capital. These funds can be obtained directly from

the shareholders or indirectly through retained profit. The higher the ratio is favorable,

since a falling ratio is usually a problem. But a higher return on equity ratio may not

necessarily mean a good financial performance. A high return on equity may be due to a

high financial leverage, which results in a threat for the company’s solvency. Return on

equity is calculated by dividing net profit by the equity.

0,00%

10,00%

20,00%

30,00%

40,00%

2011 2012 2013 2014

Net operating margin

Diageo

Remy Cointreau

9

Graph 4: Return on equity of Diageo & Rémy Cointreau (2011-2014)

The Return on equity for Diageo decreased from 33% to 29%, which is compared to Rémy

Cointreau quite high (6.64% to 6.17%). The high number tells the shareholders that

Diageo is a profitable company. In a period of four years the company’s ratios are almost

20% higher than our benchmark company. As mentioned in the annual report, the

company’s business is designed to drive returns for shareholders. The return on invested

capital also slightly decreased in comparison to last year, also between 2 and 3%. The

main reason is the general decrease in profit in 2014.

3.1.5. Return on Assets

The return on assets is a ratio that gives information on the fact if the management has

wisely used the invested financial resources, all the assets. Return on assets is a key

profitability ratio, which measures the amount of profit made by a company per dollar of

its assets. Thus, a higher ratio is more favorable. Return on assets shows whether the

return to shareholders is changing better or worse than the return on overall financing.

The ratio is calculated by dividing a company's net income (net profit before interest) by

its total assets, and is displayed as a percentage.

0,00%

10,00%

20,00%

30,00%

40,00%

2011 2012 2013 2014

Return on Equity

Diaeo

Remy Cointreau

10

Graph 5: Return on assets of Diageo & Rémy Cointreau (2011-2014)

The ratio declined slightly from 14.5% to 13% over the last four years. This tells the

shareholders and the managers of Diageo that the company uses its assets more

efficiently compared with Rémy Cointreau. The main reason that the ratio decreased was

that the amount of assets raised from £19,720 million to £22,964 million. The major

increase of assets was in 2012 by an increase of £2.5 billion of non-current assets. The

main reason that Rémy Cointreau’s ratio is so low is that its assets are much higher than

their profit before tax compared with Diageo.

3.1.6. Earnings per Share

One last way to check if the company is profitable, from a shareholder-only perspective, is

to measure the earnings per share. The term earnings per share (EPS) represents the

portion of a company's earnings (net income or net earnings) for a period that is

allocated to each share outstanding during the same period. This ratio is very important

for the investment industry and very useful to compare each company’s performance.

0,00%

5,00%

10,00%

15,00%

20,00%

2011 2012 2013 2014

Return on assets

Diageo

Remy Cointreau

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Graph 6: Earning per share (£) of Diageo & Rémy Cointreau (2011-2014)

The earnings per share ratio has slightly increased over the period of four years for

Diageo, from 81.6 pence to 95.5 pence a share. Compared to 2013, EPS was down from

103 pence to 95.5 pence per share as foreign exchange movements reduced earnings per

share by 10 pence per share. Diageo earnings per share are much lower than for Rémy

Cointreau, definitely in 2013 where the difference was around £1.5. Afterwards the ratio

dropped again almost to an equal level as Diageo. This significant drop is due the major

decline in net income, the net profit decreased more than 50% to 2013. Another big

difference between the two companies is the amount of shares outstanding, Diageo has

more or less 2.3 billion as for Rémy Cointreau it is around 49 million, which could indicate

that Diageo is much more profitable than Rémy Cointreau.

3.2. Asset Utilization Ratios

3.2.1. Total Asset Turnover

The total asset turnover ratio, as by definition, is a depiction of organizational efficiency in

relation to Diageo’s ability to keep the total asset base active. The more active the assets,

the more successful the company is in using its assets for achieving higher sales. In simple

terms, what amount of organizational assets is used to generate what level of sales during

a given period? Graph 7 depicts that the total asset turnover ratio has decreased from .50

to .45, between 2011 and 2014. A decrease in the total asset turnover ratio could indicate

0,000

1,000

2,000

3,000

2011 2012 2013 2014

Earnings per share

Diageo

Remy Cointreau

12

that Diageo’s use of its assets has become less efficient. This signifies Diageo’s

diminishing ability to generate the same level of sales with the same amount of assets.

Upon analysis of Diageo’s financial reports, the reasoning for this decrease in total asset

turnover originates from a trend of drastic increases in total assets and a minimal increase

in sales. From 2011-2014, total assets experienced 16% growth while sales only incurred a

growth percentage of only 4.47%. This 16% in total assets is due in large part to Diageo’s

increased investment in long-term assets that occurred in 2012. These increases in long-

term assets will be addressed specifically in Section 3.2.2. The overall growth in Diageo’s

net sales from 2011-2014 can be predominantly explained by their intended focus on

expanding sales through a series of acquisitions that sharpens their ability to target

emerging markets including Russia, Eastern Europe, Turkey, Africa, Latin America,

Caribbean and the Asia Pacific region excluding Australia, Korea and Japan. As found in

the 2012 Annual Report Performance Overview, net sales growth in emerging markets

accounted for 39% of overall net sales growth in 2012. This 39% was a 5% increase from

2011, which indicates a concerted effort by Diageo to expand their net sales through an

expansion of their geographical target markets.

In comparison to the benchmark, Rémy Cointreau, the total asset turnover ratios are fairly

similar in value, as they never differ by more than .1. In comparison to the overall growth

in the total asset turnover by Rémy Cointreau, the decrease in Diageo’s total asset

turnover from .50 in 2011 to .45 in 2014 indicates a decrease in the company’s efficiency

in using assets to product sales. Reasoning for Diageo’s overall decrease in asset

efficiency and Rémy Cointreau’s increase may be specifically correlated to the large

increase in Diageo’s total assets that doesn't take place within Rémy Cointreau. By

increasing the amount of assets without receiving an additionally higher amount of sales

in relation to the benchmark, it is understandable that Diageo’s asset turnover ratio would

indicate a reduction in the efficient use of the total assets.

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Graph 7: Total asset turnover ratio of Diageo & Rémy Cointreau (2011-2014)

3.2.2. Long-Term Asset Turnover

To take a more specific look at the efficiency of certain assets in producing sales, we

conduct an analysis of Diageo’s long-term asset turnover ratio. This ratio is more

specifically aimed at measuring the effectiveness of the non-current assets, identified as

Diageo’s property, plant and equipment, as well as the additional intangible assets that

include the brands, goodwill, computer software and others (Diageo, Annual Report

2014). As seen in Graph 8, Diageo’s long-term asset ratio is significantly lower than our

benchmark, Rémy Cointreau, throughout all four years of analysis. This low asset turnover,

between .66 and .78, indicates that Diageo is highly capital intensive, in that they maintain

a high level of long-term tangible assets. The most significant event we recognized in

Diageo’s continual decrease in ratio value throughout the four periods is directly related

to the high amounts of fixed costs incurred while purchasing fixed assets in 2012. The

increase in fixed assets between 2011 and 2012 directly relates to the acquisition of

control over brands in emerging markets such as Sichian Shuijingfang in Greater China

and Yeni raki, a Turkish brand previously controlled by Mey Içki, which resulted in an

estimated consideration of £1,260 billion (Diageo, 2012 Annual Report, p. 38). Throughout

2011 and early 2012, Diageo acquired brands within emerging markets throughout

Ethiopia, Philippines, Kenya, Vietnam, Turkey, China and Guatemala, which is represented

by the increase in brand value from £4,805 million to £6,153 and goodwill value from

£418 million to £1,312 million from 2011 to 2012. In addition to the brand and goodwill

value accumulated through these acquisitions, Diageo’s emergence into these markets

0

0,2

0,4

0,6

2011 2012 2013 2014

Total Asset Turnover Ratio

Diageo

Rémy Cointreau

14

was also the cause for numerous investments in global facilities including manufacturing

plants in Guatemala, a distillery in China and 6 manufacturing plants in Turkey. With these

additions to Diageo’s property, plant and equipment, Diageo incurred an increase of £420

Million from 2011 to 2012. Due to these intense efforts to expand into emerging markets

globally, Diageo’s large investment in fixed assets resulted in a large amount of long-term

assets and a lack of positively correlated high amount of sales. This disparity is

represented by the 8% decrease in the ratio from 2011 to 2012.

In comparison to our benchmark, our low and steadily decreasing long-term asset

turnover trend differ greatly from the much higher and fluctuating long-term asset

turnover in Rémy Cointreau as seen in Graph 8. This disparity in trends represents

Diageo’s limitations in having the flexible ability to reduce costs during periods of low

sales, due to their dependency on large investments in long-term assets. By having less

capital tied up in fixed assets, Rémy Cointreau is comparably less vulnerable to cyclical

fluctuations in business activity due to their ability to stay fluid but may lack in overall

global market saturation in comparison to Diageo, due to their emergence into new

markets.

Graph 8: Long term asset turnover ratio of Diageo & Rémy Cointreau (2011-2014)

0

0,5

1

1,5

2011 2012 2013 2014

Long Term Asset Turnover Ratio

Diageo

Rémy Cointreau

15

3.2.3. Inventory Turnover

The inventory turnover ratio is another management performance ratio that analyzes the

efficient use of assets through the relationship between the inventory and the amount of

goods sold during the year. The ratio signifies the average amount of times a company

acquires and sells its inventory during the year. A high inventory turnover ratio indicates

that inventory is sold quickly and suggests an efficient inventory management system.

Too high of a ratio indicates an organization incapability in having enough inventory on

hand to satisfy customers.

In the case of Diageo, Graph 9 shows an inventory turnover ratio in 2011 of 1.14 that

decreases throughout the four periods, with dramatic decreases in turnover during 2012

and 2014 of 8% and 10% respectively. These large decreases in the inventory turnover are

due to a large increase in inventories in 2012 and a large decrease in cost of sales in 2014

that is a direct result of the lack of sales faced within the emerging markets during this

period. The noteworthy reductions in Diageo’s inventory turnover significantly weaken

their ability to sell inventory quickly and ultimately reflect a less efficient inventory

management system.

Comparing Diageo to Rémy Cointreau, Diageo’s trend of decreasing turnover is also

present within Rémy Cointreau’s annual reports. During both noteworthy periods above,

Rémy Cointreau also face similar decreases in overall turnover due to increases in

inventories in 2012 and decreases in cost of sales in 2014. The most meaningful disparity

in the information lies in the large difference in their overall turnover. As stated

previously, Diageo’s inventory ratio of about 1 throughout all four periods is indicative of

an organization that is more capable of acquiring and selling inventory quickly, in

comparison to Rémy Cointreau, who’s lower ratio represents low inventory liquidity and a

slowing ability to turn inventory into sales.

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Graph 9: Inventory turnover ratio of Diageo & Rémy Cointreau (2011-2014)

3.2.4. Receivables Turnover

Like inventory turnover, receivable turnover is a critical indicator of working capital

management. Both ratios measure organizations operating efficiency and liquidity. A high

receivable turnover ratio suggests that a company is strict in credit collection and efficient

in managing funds tied up in credit-granting activities. While it is important that a

company maintain a high enough ratio level to maintain a successful level of credit sale

collections, too high of a receivable turnover ratio indicates that a company may be overly

stringent on their credit collection policies (Aerts, W. & Walton P, 2013). These strict

policies are often unattractive to customers and may negatively affect sales. While

Diageo’s receivable turnover ratio is similar to our benchmark in value throughout all four

years of analysis, the trends observed serve to explain how Diageo’s credit granting and

collection activities evolve in relation to Rémy Cointreau. As seen in Graph 10, Diageo’s

receivable turnover ratio experiences a consistent decrease in value throughout all four

years. By decreasing value from 6.54 to 5.12, we are able to assume that Diageo has

become less efficient in managing funds associated to credit granting and credit

collection. This trend is due to a larger increase in trade receivables in comparison with

the amount of credit sales accounted for during each period. This loosening stringency on

credit collection may encourage customers who value a company that is more flexible in

their credit granting and collection activities and may allow for a longer period before

requiring payment.

0

0,5

1

1,5

2011 2012 2013 2014

Inventory Turnover Ratio

Diageo

Rémy Cointreau

17

Graph 10: Receivable turnover ratio of Diageo & Rémy Cointreau (2011-2014)

Unlike Diageo, the benchmark company has a receivables turnover that shows a trend of

increasing stringency in credit granting and collection activities, represented by its overall

increase in receivables turnover during the four-year period. While Diageo’s decrease in

turnover was more continuous, Rémy Cointreau’s receivable turnover fluctuates

throughout the year due to a significant rise and fall of trade receivables occurring yearly.

As of 2014, Graph 10 shows that the values of each organizations receivable turnover

have switched places, with Diageo’s credit policies slowly evolving and becoming a less

stringent credit granter and collector in comparison to Rémy Cointreau.

3.3. DuPont Analysis

Even though ROE measures a company’s ability to increase its return on equity, it doesn’t

show much about how companies can increase their return for investors. DuPont analysis,

which was developed by DuPont Corporation in the 1920’s, further breakdowns ROE into

three parts: profit margin, asset turnover and equity multiplier. The three components of

DuPont analysis measure the following financial situations of a company:

Profitability (measured by profit margin)

Operating efficiency (measured by asset turnover)

Financial leverage (measured by equity multiplier)

This analysis allows analysts to understand different sources of return by comparison with

companies in similar industries. When ROE is not satisfactory, DuPont analysis can help

0

2

4

6

8

2011 2012 2013 2014

Receivable Turnover Ratio

Diageo

Rémy Cointreau

18

pinpoint the part of the business that is underperforming. It shows that a company can

raise its ROE by maintaining a high profit margin, increasing asset turnover, or leveraging

assets more effectively.

The basic formula of DuPont analysis is as follows:

𝑅𝑂𝐸 = (𝑃𝑟𝑜𝑓𝑖𝑡 𝑚𝑎𝑟𝑔𝑖𝑛) ∗ (𝐴𝑠𝑠𝑒𝑡 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟) ∗ (𝐸𝑞𝑢𝑖𝑡𝑦 𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟)

= (𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡/𝑆𝑎𝑙𝑒𝑠) ∗ (𝑆𝑎𝑙𝑒𝑠/𝐴𝑠𝑠𝑒𝑡𝑠) ∗ (𝐴𝑠𝑠𝑒𝑡𝑠/𝐸𝑞𝑢𝑖𝑡𝑦)

= (𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡/𝐸𝑞𝑢𝑖𝑡𝑦)

The calculations for Diageo and Rémy Cointreau are displayed in tables 3 and 4:

Diageo 2011 2012 2013 2014

Profit margin 0.26 0.29 0.30 0.26

Asset turnover 0.50 0.48 0.45 0.45

Equity

Multiplier

3.31 3.28 3.09 3.03

ROE=DuPont 0.43 0.46 0.42 0.36

Table 3 – DuPont ratios of Diageo

2011 2012 2013 2014

Profit margin 0.13 0.20 0.20 0.14

Asset turnover 0.41 0.52 0.53 0.45

Equity

Multiplier

2.06 2.04 2.07 2.25

ROE=DuPont 0.11 0.21 0.22 0.14

Table 4 – DuPont ratios of Diageo

Graph 11 shows that overall Diageo’s ROE is above industry standard (Rémy Cointreau),

whereas both Diageo and Rémy Cointreau have undergone major ROE increase from

2011 to 2012 and major decline from 2013 to 2014. If the economical environment and

companies’ strategies remain unchanged, there may be further declines of ROE in both

19

companies. Further DuPont analysis is conducted below to explain the reasons and

pinpoint the problems.

Graph 11: DuPont (ROE) analysis of Diageo & Rémy Cointreau (2011-2014)

3.3.1. Profit Margin

Graph 12: DuPont (profit margin) analysis of Diageo & Rémy Cointreau (2011-2014)

Profit margin is a profitability ratios measures the amount of net income earned with each

pound of sales. It shows if the company is efficient enough to convert sales into net

income. When the profit margin is too high compared to the industry average, it indicates

that the company needs to cut budget and expenses. Investors look at the profit margin

of a company to make sure the profit is high enough to distribute dividends while

creditors use it to predict if the company has enough profits to pay back its debts.

Managers always use profit margin ratios to set performance goals for a company.

0

0,1

0,2

0,3

0,4

0,5

2011 2012 2013 2014

RO

E

Diageo & Rémy Cointreau

Diageo

Rémy Cointreau

0

0,1

0,2

0,3

0,4

2011 2012 2013 2014

Pro

fit

Ma

rgin

DuPont Analysis

Diageo

Rémy Cointreau

20

We can see from our calculation that Diageo’s profit margin is above Rémy Cointreau’s

while they both went through the same trend from 2011 to 2014, namely increase from

2011-2012, stagnation from 2012 to 2013 and decrease from 2013 to 2014. Compared

with Rémy Cointreau, Diageo can generate more profit from each dollar of sales. Even

though from 2013 to 2014 both companies’ profit margin diminished mainly due to

decreased sales, Diageo made use of its expenses more efficiently and made more profits

from its sales. From the notes 4, “Exceptional Items” of the financial report of Diageo,

we learnt that “on 30 January 2014 Diageo announced its plan to restructure the

organization and deliver further operating efficiencies, including reorganization of teams

in the markets working within regions and global functions, reconfiguration of

procurement, logistics and shared services and transformation of information services”

(Diageo, Annual Report, 2014). This gave part of the reasons why Diageo uses expenses

more efficiently.

3.3.2. Asset Turnover

The asset turnover ratio measures a company’s ability to generate sales from its assets. It

calculates how many sales have been generated from each dollar of company assets. In

other words, it shows how efficiently a company can use its assets to generate sales.

Higher asset turnover ratios mean the company is using its assets more efficiently. On the

contrary, lower ratios mean that the company isn't using its assets efficiently and most

likely have management or production problems.

21

Graph 13: DuPont (asset turnover) analysis of Diageo & Rémy Cointreau (2011-2014)

In terms of asset turnover, Diageo performed worse and worse from 2011 to 2014. Its

turnover ratio was below Rémy Cointreau in 2012 and 2013, and the same as Rémy

Cointreau in 2014. Even though the total assets of Diageo kept increasing from 2012 to

2013 (only decreased in 2014), the sales didn’t increase so much (even decreased in 2014).

The increase in assets was partially due to the company’s global acquisition. For example,

in the year ended 30 June 2013 the company acquired a 10.04% investment in United

Spirits Limited (USL) and in 4 July 2013 it increases the investment to 25.02%, which

turned the investment from available-for-sale to associates. The decrease in assets is

attributable to the impairment of brands, goodwill and other intangible assets (especially

in 2014). The company mainly relied on reducing expenses rather than producing more

sales to make more profits.

0

0,2

0,4

0,6

2011 2012 2013 2014

Ass

et

Tu

rno

ve

r

DuPont Analysis

Diageo

Rémy Cointreau

22

3.3.3. Equity Multiplier

Graph 14: Equity multiplier of Diageo & Rémy Cointreau (2011-2014)

The equity multiplier compares total assets with total shareholder’s equity to measure the

amount of a firm's assets that are financed by its shareholders. This is a financial leverage

ratio that shows the level of debt financing is used to acquire assets and maintain

operations. It indicates the company risks to its creditors. Companies that rely too heavily

on debt financing will have high debt service costs and thus considered to be highly

leveraged and more risky for investors and creditors. In practice, higher equity multiplier

ratios are very often considered to be less favorable than lower ratios because higher

ratios indicate more dependence on debt and high debt servicing costs. In DuPont

analysis, higher equity multiplier ratios bring higher ROE.

From the calculation we can see that Diageo has higher multiplier ratios than Rémy

Cointreau from 2011 to 2014. However, Diageo’s ratios slowly decrease whereas Rémy

Cointreau’s ratios gradually climb over these years. In the year of 2014, the difference

between the ratios of these two companies on equity multiplier was much smaller than at

the beginning of 2011. This shows that Diageo becomes less dependent on debts, which

should be viewed as positive change towards financial risks. At the same time, diminishing

multiplier ratios negatively affected ROE. Possible reasons for this decrease can be found

on the financial statements of Diageo. From 2011 to 2014, the total assets of Diageo

increased 16.5% but total equity has increased 27.4%. The company grows its equity by

0

1

2

3

4

2011 2012 2013 2014

Eq

uit

y M

ult

ipli

er

DuPont Analysis

Diageo

Rémy Cointreau

23

purchasing shares (7,690,724 shares in total from September 2013 to March 2014),

consolidating non-controlling interests, and increasing its retained earnings. Borrowings

and new bonds were reduces during the relevant years. Compared with Rémy Cointreau,

Diageo adopted a more conservative approach to finance its assets.

3.4. Capital Market Analysis

3.4.1. Price-to-Earnings Ratio

To gain an insight in the worth of stocks and how to value them, one has an abundance

of figures, graphs and tools he or she can look into. Nonetheless, one of the most

frequently used tools to value a stock is to use the Price Earnings Ratio (hereafter also

‘P/E’), which can give a good view on the stock price of a specific company or index.

Stating that one ratio is the key to successful valuating a company’s stock price would,

however, be blunt and unjust.

The P/E allows one to see how the price of a share stands compared to the earnings per

share, based on known earnings per share of the past 12 months (thus the P/E functions

as a tool of analysis rather than prediction of future value). Yet, even though the P/E

reflects how the market rates the (past) performance of a company it also functions as

indicator of the expectations by the market of the future growth of the company. The P/E

itself shows how much the market is willing to pay per dollar of the company’s future

earnings. As such, one can conclude that the P/E can be used as a predictor of the

company’s future, as a high P/E equals a high amount of faith by the market that the

company will have high future earnings.

The calculation of the P/E is in itself is quite simple:

Price Earnings Ratio = Market price per share

Earnings per share

24

3.4.2. Dividend Yield Ratio

Another interesting ratio concerning the capital market is the Dividend Yield Ratio. After

all, when one invests in stocks he or she will often aim to see both an increase in the

worth of the share and the payment of dividends from that stock. While the prior could

be ‘predicted’ through the use of the P/E ratio, the Dividend Yield Ratio (hereafter also

‘D/Y’) will provide investors a useful tool for the latter.

The D/Y provides the market with information on how much dividends are paid in

comparison with the price of the stock, presented as a percentage of how much of the

stock price is returned in dividends each year.

The calculation of the D/Y ratio:

Dividend Yield Ratio = Dividend per share

Market price per share

3.4.3. Market Analysis

To apply both the P/E and the D/Y ratio on Diageo and Rémy Cointreau, we first need

their stock prices. For Diageo, we refer to the Diageo stock on the London Stock Exchange

(DGE:LSE). For Rémy Cointreau we refer to the stock on the Paris Stock Exchange

(RCO:PAR).

25

Price Earnings Ratio

When we look at the P/E of Diageo, we notice a steady increase from 2011 till 2014, with

a total increase of 25,26% as of 2014. This suggests that the stock has an increased

potential according to the market with higher earnings in the (near) future. The increase is

very stable which means that the market doesn’t expect a sudden peak of earnings for

this company but rather a steady growth. Additionally, since average P/E ratios sit

between 15 and 25, Diageo is moving from the lower to the middle area of the market

average.

When comparing the P/E of Diageo with the P/E of Rémy Cointreau, two main differences

become apparent. The P/E of Rémy Cointreau is in general much higher, promising higher

increased earnings in the future than Diageo. However, the high P/E of Rémy Cointreau

might just as well indicate that the earnings were low compared to the potential earnings

(which can be considered a good and bad sign at the same time). And rather than

noticing a steady increase like we saw at Diageo, we are presented with a rather steep

dive (-25% between 2011 and 2013) followed up by an even steeper increase (+75%

between 2013 and 2014). Either way, Rémy Cointreau will have to show a steep increase in

earnings or accept that the stock is overpriced.

Whereas Diageo had a smaller decrease of both share price (-1,64%) as EPS (-7,77%)

whilst their net profit dropped by ‘only’ 14,48%, we notice more ‘dramatic’ figures at

Rémy Cointreau. The latter appeared to have had a sudden peak in the P/E due to a

tremendous drop in EPS (which dropped from 2,30 in 2013 to 1,02 in 2014, a decrease of

55,65%) as a result of disappointing results (decrease of net profit by 46,9% and in

increase in net debt of 148 million euros).

26

Graph 15: P/E Ratio of Diageo & Rémy Cointreau (2011-2014)

Dividend Yield Ratio

When looking at the D/Y ratio, we notice a decrease from 2011 to 2013 with an increase

in 2014, ending with a decrease of 12,62% compared to 2011. This decrease in D/Y is not

the result of paying fewer dividends, as Diageo steadily increased the amount of

dividends paid per share (+27,97% in 2014 compared to 2011 with a steady growth in

between). The main reason for the decrease in Diageo’s D/Y is the increase of the market

price per share, with the exception of the year 2014 where the market price per share

dropped by 1,64% compared to 2013 resulting in an increase of Diageo’s D/Y with 10,8%.

When looking at the D/Y of Rémy Cointreau, we see a strong decrease from 2011 till 2013

with an increase towards 2014. We see a somewhat similar trend between both

companies, yet the decrease is much steeper for Rémy Cointreau (-51,19% from 2011 till

2013). This is the result of an increasing market price per share and the strong decreases

in paid dividends from 2011 till 2013. Also in 2014 the paid dividends decreased, but the

market price per share dropped as well which balanced the numerator and denominator

resulting in a positive D/Y ratio.

To conclude, one can see that the D/Y of Diageo is higher in 2014 (+50,54% compared to

Rémy Cointreau) with a much more stable P/E, which makes Diageo look like the better

investment.

0,00

20,00

40,00

60,00

2011 2012 2013 2014

Price Earnings Ratio

Diageo

Rémy Cointreau

27

Graph 16: Dividend Yield Ratio of Diageo & Rémy Cointreau (2011-2014)

Table 5 – Capital Market Perspective Ratios for Diageo

Table 6 – Capital Market Perspective Ratios for Rémy Cointreau

0,00%

1,00%

2,00%

3,00%

4,00%

2011 2012 2013 2014

Dividend Yield Ratio

Diageo

Rémy Cointreau

DIAGEO

Capital Market Perspective Ratios

2011 2012 2013 2014

Price-to-Earnings

Ratio

15,60

17,73

18,40

19,54

Dividend Yield Ratio 3,17%

2,65%

2,50%

2,77%

REMY COINTREAU

Capital Market Perspective Ratios

2011 2012 2013 2014

Price-to-Earnings

Ratio

40,27

38,43

30,28

52,96

Dividend Yield Ratio 3,77%

2,63%

1,68%

1,84%

28

4. CONCLUSIONS AND RECOMMENDATIONS

4.1. Conclusions

We will now conclude with an overview of the information we’ve gathered on the financial

practices of Diageo PLC. As noted above, we’ve looked into the profitability and asset

utilization – besides that, we took DuPont Analysis and capital market analysis into

account.

In terms of profitability, we ran six ratio’s: net profit margin, gross operating margin, net

operating margin, return on equity (ROE), return on assets (ROA) and earnings per share

(EPS). When investigating the first of these, net profit margin, we noticed that Diageo’s

margin is much higher than that of Rémy Cointreau, most likely because of their lower

sales. However, tax payments seem to be the main reason for these differences: Diageo’s

net profit represents 82% of profit before tax, in contrast with Rémy’s 50%. Diageo’s gross

profit margin, often used by an inventor to assess efficiency, seems to be pretty much

equal compared to our benchmark. However, Diageo’s ratio rose relatively consistently,

while the benchmark ratio grew about 3% - this is because their sales have gone up, while

their cost of goods sold remained the same. Third, we see an equal evolution in net

operation margin, one that goes up and down over the course of four year. Nevertheless,

we found that Diageo ears £0.26 as operating earnings out of each pound, while Rémy

Cointreau only gets earns £0.14, which explains the difference. Next, we had a look at

ROE, where we see that Diageo’s ratio is about 23 percentage points higher than Rémy’s,

meaning that Diageo is a profitable company. In terms of ROA, we see that again Diageo

has a higher ROA ratio than the benchmark company, albeit a lower one than four years

ago, mostly because of a high rise in the amount of assets, mostly non-current assets.

Finally, we had a look at the EPS rate. Rémy Cointreau had double or more than double

the EPS of Diageo for quite some time, but it fell sharply between 2013-2014. Now, both

ratio’s are much closer together. On top of that, Diageo has much more share

outstanding than the benchmark.

29

When looking at asset utilization, there were four ratios we took into account. These were

total asset turnover, long-term asset turnover, inventory turnover and receivables

turnover. First, we had a look at total asset turnover, ratios that are fairly similar in value.

Diageo’s total asset turnover decreased, mainy because of their higher amount of assets

without a subsequent raise in sales. In terms of long-term asset turnover, we see that

Rémy’s ratio is higher than Diageo’s. We see again that the latter company invested in a

large amount of long-term, fixed assets, without the same increase in sales, which leads to

a disparity. This means that Diageo is limited in its ability to reduce costs during periods

of low sales, which results in Rémy being less vulnerable to cyclical fluctuations. On the

other hand, Diageo has an advantage because it’s penetration new markets. Third, we

investigate inventory turnover. We notice that both companies have a decreasing trend

over four years. Both companies have similar decreases in inventories and decreases in

cost of sales, while the disparity lies in the large difference in overall turnover: Rémy has

lower inventory liquidity. Last, we had a look at receivables turnover. While Diageo’s

decreased over four years, the benchmark ratio has increased over the same period of

time. Diageo’s policy seems to have switched to a less stringent credit granter compared

with the benchmark.

When we take the DuPont analysis into account, we see that the profit margin of both

companies follow similar trends, with a decrease in 2013 due to a decrease in sales.

However, Diageo seems to make better use of their expenses. Second, asset turnover is at

about the same point in 2014 for both companies. However, Diageo did some

acquisitions during the period that led to higher assets, but also included impairment,

goodwill and other intangibles. Lastly, we investigated the equity multiplier, which brings

a higher ROE the higher it gets. Diageo’s equity multiplier is higher than Rémy’s, but we

notice that the difference has decreased over time. Possible reasons are the equity growth

through shares purchases, consolidation of non-controlling interests and increasing

retained earnings – a more conservative approach compared to Rémy Cointreau.

Finally, we did a capital market analysis and we took a look at price-to-earnings ratio

(P/E), dividend yield ratio (D/Y) and a subsequent market analysis. The P/E ratio of Rémy

Cointreau is in general higher, which might indicate higher earnings for shareholders, but

30

also low earnings compared to potential earnings. A steep increase might as well indicate

an overpriced stock price for Rémy Cointreau. Compared with their benchmark, Diageo

has shown a very steady and slow increase in P/E. In terms of D/Y ratio, in contrast,

Diageo scores higher than their benchmark competitor whose D/Y ratio has almost

halved. Combined with a more stable P/E ratio, Diageo might seem the better investment.

4.2. Recommendations

Due to Diageo’s status as an international organization with constant interest in

expansion, we recommend Diageo continue maximize their strength held in their high

capital intensity. As signified by their high long-term asset turnover ratio, Diageo’s

investment in long-term fixed assets can be potentially used as a key strength in their

strategy. Diageo’s recent investment in property, plants and other facilities throughout

locations such as China and Turkey is evidence of their interest in expanding their global

network of brands and consumer markets. To maximize their profitability we recognize

that this ratio must be stringently monitored. Diageo must be willing to make adaptations

to ensure that these massive investments in new brands, and the costs associated to their

global production, are allocated properly and efficiently to maximize the potential

profitability of their investments.

From DuPont analysis we can see that Diageo mainly relied on reducing expenses rather

than producing more sales to make more profits. It adopted a more conservative

approach to finance its assets and generate profit. In order to stimulate organic growth,

Diageo should invest more in marketing (including market research), product

development, sales and promotion. Explore and expand new market should be among the

primary goals of the company.

31

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