Morning Note: Market news and an update from Diageo.
Market News
US equity-index futures have dropped – S&P 500 (-1.1%); Nasdaq (-1.4%) – and the Treasuries yield curve has steepened after Moody’s Ratings stripped the US government of its top credit rating, citing a ballooning budget deficit it said showed little sign of narrowing. Scott Bessent told NBC the ratings firm is a “lagging indicator.” Longer-dated Treasury yields rose to touch the psychological 5% level. A gauge of the dollar weakened 0.2%, while gold edged up to $3,230 an ounce.
In Asia this morning, equities were also soft – Nikkei 225 (-0.7%); Hang Seng (-0.1%) – even though China’s industrial output expanded faster than expected in April. Some Wall Street firms are betting Emerging Market equities will outperform US stocks – AQR predicts they’ll deliver local-currency returns of almost 6% annually in the next 5-10 years, outpacing a 4% gain for American shares in dollars.
The FTSE 100 is currently 0.5% lower at 8,645, while Sterling trades at $1.3320 and €1.1880. EU and UK negotiators reached a deal to strengthen their bilateral relationship ahead of a summit meeting today, people familiar said. According to Rightmove, UK house prices rose by 0.6% month-on-month in May, from +1.4% previously.
Brent Crude futures moved below $65 a barrel, with investors closely watching developments in the Iran-US nuclear talks.
Donald Trump said he’ll have a call with Vladimir Putin today to discuss ending the war in Ukraine. Russia is preparing a list of conditions for a possible ceasefire and will exchange it with Kyiv privately.
Source: Bloomberg
Company News
As part of a commitment to provide more regular updates, Diageo has released a trading statement for the quarter ended 31 March 2025. Against an uncertain backdrop, sales growth has continued to recover and guidance for the financial year to 30 June 2025 has been reiterated. The company has launched the first phase of a new restructuring programme and has announced it will sustainably deliver $3bn of free cash flow per annum from next year. The market has chosen to overlook the slower pace at which financial gearing will return to its target range and the shares have been marked up by 1% in early trading ahead of the analysts’ call later this morning.
Diageo is a leading global drinks company, with a unique portfolio of iconic brands including Johnnie Walker, Smirnoff, Captain Morgan, Baileys, Tanqueray, and Guinness. The company owns 13 billion-dollar brands across a broad range of categories that are gaining share from beer and wine. The group is an integrated operator, producing and supplying drinks at a variety of price points across strong global distribution routes. In the long term, we believe Diageo is well placed to benefit from the trend towards premiumisation – including its 34% stake in Moet Hennessey, the group generates more than 60% of its sales from high margin, premium brands. The group has a strong presence in under-penetrated emerging markets, where the number of people of legal purchasing age is set to increase by over 600m by 2030. Wealth is also increasing in these regions, with the middle class expanding and consumers shifting from local products to higher-margin premium international brands.
However, the global industry environment has been challenging of late. In addition to a rebasing of consumer spending in the aftermath of the pandemic spending boom, the sector faces potential headwinds from the impact of weight-loss drugs on alcohol consumption and the request by the US Surgeon General for alcoholic drinks to carry warnings of their links to cancer. Other structural threats include Gen-Z moderation and cannabis cannibalisation. Further political risk comes from the proposed tariffs by the new Trump administration. We believe these factors will have less of an impact than currently feared, while the company is also introducing innovative new products.
In response, the company is focused on strengthening the resilience of its business through operational excellence, productivity, and strategic investments to win market share. The new CFO is expected to bring greater discipline on costs and a renewed focus on growth, profit, and cash. With that in mind, the company has today launched the first phase of its Accelerate programme which sets out clear cash delivery targets and a disciplined approach to operational excellence and cost efficiency. Full details of the programme will be shared at the full-year results on 5 August. For now, the company has revealed it expects to sustainably deliver around $3bn free cash flow p.a. from FY2026, increasing as the business performance improves. Cost savings of $500m over the next three years will enable both reinvestment in future growth and improved operating leverage. The company remains committed to deleveraging its balance sheet and expects to be well within the target range of 2.5x-3.0x net debt/EBITDA no later than FY2028. This will be delivered through a combination of organic growth and positive operating leverage, combined with tighter capital discipline, and appropriate and selective disposals over the coming years.
During the three months to 31 March 2025, reported net sales increased by 2.9% to $4.4bn. Organic net sales (which excludes M&A and currency impact) rose by 5.9%, with a strong contribution from organic volume growth, up 2.8% and positive price/mix of 3.1%.
Overall, organic net sales growth was supported by significant phasing benefits estimated to have contributed around 4% of organic net sales growth, with about two-thirds from North America (NAM) and to a lesser extent Latin America & Caribbean (LAC). The company expects most of this benefit to unwind in the current quarter, most significantly in NAM where a pull-forward of imported shipments in anticipation of tariffs favourably impacted results. NAM performance was also supported by continued tequila restocking given strong Don Julio consumer sales performance. In LAC, strong double-digit organic net sales growth (+28.5%) was driven by lapping a particularly soft comparative period of significant destocking. To a lesser extent, Asia Pacific (+1.6%) was also lapping an easier comparative period. Europe fell by 0.4%.
We estimate that stripping out the phasing benefits, organic sales growth was around 2%, as expected an acceleration from the 1% growth rate in the group’s first half.
As expected, this update only covers sales so there is less detail on profitability or the group’s financial position. As a reminder, the company earns an attractive operating margin in the high-20s, while at the last balance sheet date (31/12/2024), financial gearing was 3.1x net debt to EBITDA, just above the upper end of the target ratio of 2.5x-3.0x. Leverage is expected to remain above the target leverage range at the full-year stage of 30 June 2025, although the guidance of 3.3x to 3.5x is a bit higher than we expected. As highlighted above, the company remains committed to returning to its target range, albeit not until FY2028. In the meantime, the dividend is being maintained to generate a yield of 3.7%.
The company has disclosed that assuming the current 10% tariff remains on both UK and European imports into the US, that Mexican and Canadian spirits imports into the US remain exempt under USMCA, and that there are no other changes to tariffs, the unmitigated impact of these tariffs is estimated to be $150m on an annualised basis. Tariffs between the US and China do not have a material impact on the business. Diageo expects that given the actions that are already in place, before any pricing, the company will be able to mitigate around half of this impact on operating profit on an ongoing basis. Looking ahead, the group will continue to work on measures to mitigate this impact further. The expected impact in FY2025 and FY2026 is included in the group’s guidance.
At the time of its results in February the group removed its medium-term guidance – annual organic net sales growth of 5% to 7% – due to the current macroeconomic and geopolitical uncertainty in many of its key markets impacting the pace of recovery. However, management remain confident of favourable industry fundamentals and Diageo’s ability to outperform. The aim is to increase its value share of the total beverage alcohol (TBA) market from 4.7% in 2023 to 6% by 2030.
Guidance for the financial year to 30 June 2025 has been reiterated. In the second half (i.e. the six months to 30 June), the company continues to expect to deliver a sequential improvement in organic net sales growth compared with the first half (i.e. +1.0%). The company continues to expect a slight decline in organic operating profit in the second half of FY2025 compared with the prior year, broadly in line with the decline in the first half (i.e. -1.2%). This includes the impact of the tariffs currently announced.
The company has also initiated guidance for FY2026 where it expects to deliver positive operating leverage, with organic profit growth ahead of organic net sales growth. This includes the impact of US tariffs based on what the company knows at this time.
Source: Bloomberg
