Morning Note: Market news and updates from BP and Diageo.

Market News

Traders are increasingly pricing in interest rate cuts by the Federal Reserve after Friday’s weak job report, with some analysts citing a “99% chance” that the Fed will cut rates by 25 basis points in September. Mary Daly said the time for rate cuts is nearing, telling Reuters more than two reductions might be needed if labour market weakness persists. US Treasury yields continued to drop – the 10-year trades at 4.21%. Gold pushed higher during yesterday’s session to $3,375 an ounce, while US equities enjoyed a strong rally – S&P 500 (1.5%); Nasdaq (+2.0%).

President Trump said he would be “substantially raising” the tariff on Indian exports to the US over India’s purchase of Russian oil. The US is threatening secondary sanctions on countries that purchase Russian energy, with Matt Whitaker, the US ambassador to NATO, saying such sanctions are an “obvious next step” to try to bring the war in Ukraine to an end. India’s Ministry of External Affairs said “the targeting of India is unjustified and unreasonable” and that India will take measures to safeguard its national interests and economic security.

The US is looking into ways to improve the location-tracking of AI chips as part of its plan to curtail smuggling and the flow of semiconductors to China and other restricted markets.

In Asia this morning, equity market also saw gains: Nikkei 225 (+0.6%); Hang Seng (+0.5%); Shanghai Composite (+1.0%). China’s services activity unexpectedly picked up in July, a private survey showed, indicating resilience during the summer travel season. The FTSE 100 is currently 0.2% higher at 9,147, while Sterling trades at $1.3270 and €1.1495.

Source: Bloomberg

Company News

BP has today released Q2 results which were better than market expectations. The strategic programme is proceeding to plan, and the company has hinted at more to come when the new Chairman starts his tenure. The company has raised its quarterly dividend by 10% and announced another $750m share buyback in the current quarter. The shares are trading 2% in early trading.

Over the last five years, BP has been gradually transforming from an International Oil Company (IOC) to an Integrated Energy Company (IEC). However, performance has been disappointing, and the market has questioned the company’s ability to generate a return on investment at a time when the world was more focused on security of supply and affordability. As a result, the group’s share price performance relative to industry peers has been poor.

Earlier in the year, BP announced a reset of its strategy which will involve reducing and reallocating capital expenditure, significantly reducing costs, and driving improved performance in cash flow and returns to support a stronger balance sheet and resilient distributions. Some shareholders would have liked the company to go further, and we note the appointment last month of Albert Manifold as the company’s new Chairman as of 1 October. He was CEO of building materials group CRH for 10 years until December 2024 and has ‘a strong track record of strategic leadership and operational delivery with a focus on cost efficiency, disciplined capital allocation and cash flow generation’.

With today’s update, the company highlights that the CEO has been in discussions with the new Chairman and has agreed the company will conduct a thorough review of the portfolio of businesses to ensure the company is maximising shareholder value moving forward. The company will also initiate a further cost review. 

In the meantime, in the Upstream business (i.e. exploration & production), the company is increasing investment in oil & gas to $10bn p.a. (split 70% oil; 30% gas) and targetting returns of more than 15%. The portfolio will be strengthened, with 10 new major projects expected to start up by the end of 2027, and a further 8-10 by 2030. Production is set to grow to 2.3m-2.5m barrels a day in 2030, albeit it still below the 2019 level. The aim is to generate structural cost reductions of $1.5bn and an additional $2bn of operating cash flow by 2027.

The Downstream division (i.e. refining & marketing) is being high-graded and will focus on advantaged and integrated positions, while a strategic review of Castrol is ongoing. The focus will be on operating performance with a target to consistently improve refining availability to 96%. Capital investment will be $3bn by 2027, with a target of $2bn in cost savings. Overall, the aim is to generate an additional $3.5bn–$4.0bn of operating cash flow in 2027 and returns of more than 15%.

Investment in the group’s ‘transition’ businesses is being slashed from $5bn p.a. to $1.5bn–$2bn p.a., with less than $0.8bn p.a. in low carbon energy. The focus will be on fewer but higher-returning opportunities and more efficient growth. There will be selective investment in biogas and biofuels. In renewables, the focus will be capital-light partnerships, while there will be limited further projects in hydrogen and Carbon Capture & Storage. The group is targeting an annual structural cost reduction of more than $0.5bn in low carbon energy by 2027.

Back to today’s results. In the three months to 30 June 2025, underlying replacement cost profit – the key measure of the group’s performance – fell by 15% to $2.35bn, well above the market forecast of $1.82bn. Compared with the previous quarter, the result was up 70%, reflecting an average gas marketing and trading result, stronger realised refining margins, stronger customers result, a strong oil trading result, partly offset by lower liquids and gas realisations and significantly higher level of refinery turnaround activity.

By division, the results for the quarter for underlying operating profit were: gas & low carbon energy (+4%); oil production & operations (-27%); and customers & products (+33%). Upstream production fell by 3% to 2.3bn b/d and is still expected to be slightly lower in the full year.

The group started five major projects and made 10 exploration discoveries. Yesterday, the company announced significant discovery at the Bumerangue exploration well, deepwater offshore Brazil, its largest in 25 years.

The company is targeting significantly higher structural cost reductions of $4bn–$5bn by the end of 2027 versus a 2023 base. In the first half of 2025, $0.9bn of savings were delivered, amounting to $1.7bn so far.

Capital expenditure was $7.0bn in the first half and the group still expects full-year spend of $14.5bn. Operating cash flow fell by 23% in Q2 to $6.27bn, reflecting higher earnings and lower working capital build. By 2027, the aim is to generate compound annual growth in adjusted free cash flow of more than 20% at $70/barrel oil price and returns on average capital employed of more than 16%. Note the oil price is currently $68 a barrel.

The group is targetting $20bn of divestments by 2027, including $3bn-$4bn this year. Expected proceeds from completed or announced divestments have reached around $3bn for the year. This includes potential proceeds from Lightsource bp and the strategic review of Castrol. There are no plans for major acquisitions.

During the quarter, net debt fell from $27.0bn to $26.0bn, with gearing of 24.6%. We note, however, the net debt figure doesn’t include $12.5bn of lease liabilities and $8bn of Gulf of Mexico oil spill payables. BP remains committed to maintaining a strong investment grade credit rating and a reduction in net debt to $14bn–$18bn by the end of 2027. This is seen as a more suitable level in a cyclical industry and will drive resilient shareholder distributions of 30%–40% of operating cash flow over time.

Shareholders returns are made by way of a dividend which is expected to increase by at least 4% a year and a share buyback programme. Today, the group has declared a quarterly dividend of 8.32c, 4% higher than last year, implying a full-year yield of 6%. The $750m share buyback programme announced with the Q1 results was completed on last week. Related to the Q2 results, the company intends to execute a $750m buyback prior to reporting the Q3 results.

Overall, we believe decarbonisation can’t happen at the flick of a switch – oil and gas will remain part of the global energy mix for decades, with demand driven by population growth and higher incomes, particularly in developing countries where the desire for energy intensive goods and services like cars, international travel, and air conditioning is rising. We also believe the production of the materials needed to transition to net zero can’t happen without using hydrocarbons. At the same time, reduced investment in new production, partly because of environmental concerns, and natural decline rates, are increasingly leading to constrained supply.

Against this backdrop, BP is looking to reduce emissions in a way that delivers attractive returns for shareholders at a time of macroeconomic and geopolitical uncertainty. However, investor disillusion with the group’s low carbon strategy, particularly in terms of capital discipline, has had a negative impact on the share price, especially relative to the peer group, leaving them on a very undemanding valuation. This has also attracted the attention of activist investor Elliott Investment Management which now holds a 5% stake and is calling for a more structural transformation. Furthermore, in June there was speculation that Shell was actively considering making an offer for BP. Although Shell issued a denial statement, we believe BP’s current valuation and the presence of Elliot on the shareholder register means M&A speculation is unlikely to die down.

Source: Bloomberg

Diageo has released results for the financial year to 30 June 2025. The figures were a touch ahead of the company’s guidance and the dividend has been maintained. Further details have been provided on the Accelerate restructuring programme and the target for cost savings has been raised.

In the current financial year (FY2026), market conditions are expected to remain challenging with organic sales growth similar to FY2025, albeit down slightly in the first half. Organic operating profit growth in the mid-single-digits is slightly better than the current market forecast.  In response, the shares have been marked up by 6% 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. Current research suggests these factors will have less of an impact than currently feared, while the company is also introducing innovative new products. Further political risk comes from the proposed tariffs by the new Trump administration.

In the medium term, we expect the structural tailwinds highlighted above to more than offset the headwinds to support positive industry growth. In addition, Diageo is focused on strengthening the resilience of its business through operational excellence, productivity, and strategic investments to win market share.

Last month, the company announced that its CEO has stood down with immediate effect, by mutual agreement. Until a permanent appointment is made, the CFO has assumed the role of CEO on an interim basis.

The first phase of the company’s Accelerate programme is progressing well and involves cash delivery targets and a disciplined approach to operational excellence and cost efficiency. These include:

-          to sustainably deliver around $3bn free cash flow p.a. from FY2026, increasing as the business performance improves.

-          cost savings have been raised from $500m over the next three years to $625m. 50% of the benefit is expected to drop through to operating profit, with the rest enabling reinvestment in future growth.

-          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.

-          opportunities for ‘substantial changes’ to the portfolio by offloading assets that are not ‘core or strategic’. In particular, they are looking at capital intensive businesses where they can get an attractive price. Recent disposals have been made in Italy, Ghana, and The Seychelles.

Back to the results for the financial year to 30 June 2025. Trading conditions remained challenging throughout the year, reflecting macroeconomic and geopolitical uncertainty as well as weak consumer confidence in many key markets, including the US and China.

Reported net sales edged down by 0.1% to $20.2bn, in line with the market forecast. Organic net sales (which excludes M&A and currency impact) rose by 1.7%, versus the consensus forecast for a 1.4% increase. The company guidance was to deliver a sequential improvement in organic net sales growth compared with the first half (i.e. +1.0%). Price/mix grew by 0.8%, while organic volume grew by 0.9%.

The four percentage points of phasing which favourably benefitted Q3 organic net sales growth rate mostly reversed in the final quarter.

Growth was driven by strong performance from Don Julio (+38%), Guinness (+13%), and Crown Royal Blackberry. Total trade market share grew or remained stable in 65% of total net sales in measured markets, including in the US.

North America, the group’s largest market (54% of profit), generated organic sales growth of 1.5%, including US spirits growth of 1.6%. Elsewhere growth in Latin America & Caribbean (+9.2%), Europe (+0.3%), and Africa (+10.5%) was offset partly by a decline in Asia Pacific (-3.2%).

Operating profit fell by 0.7% in organic terms to $5,704m. This was slightly better than the market forecast and the company guidance. The margin fell by 68 basis points in organic terms to 28.2%, mainly due to continued investment in overheads, partly offset by slight gross margin expansion. Adjusted EPS fell by 8.6% to 164.2c, better than the consensus forecast of 161.6c.

Free cash flow rose slightly to $2.75bn, versus expectations of $2.46bn, and driven by strong working capital management and capex of $1.5bn. After a period of elevated spend in recent years, capex will decline to $1.2bn-$1.3bn in FY2026.

Financial gearing ended the year at 3.4x net debt to EBITDA, in line with guidance of 3.3x-3.5x. The company remains committed to returning to its target range of 2.5x-3.0x ‘no later than’ FY2028 and by then gearing will be in the middle of the range. The full-year dividend was maintained at 103.48c, a yield of 4.3%.

Diageo has a long-term track record of coping with tariffs. The company has continued to undertake considerable contingency planning in recent months and is focused on what it can control in relation to tariffs. Assuming the current 10% tariff remains on UK and 15% European imports into the US, that Mexican and Canadian spirits imports into the US remain exempt under the US - Mexico - Canada Agreement (USMCA), and that there are no other changes to tariffs, the unmitigated impact of these tariffs is estimated to be c.$200m on an annualised basis. As a result of the group’s extensive supply chain and broad and advantaged portfolio, the company has undertaken a number of actions to help mitigate the potential impact including inventory management, supply chain optimisation, and re-allocation of investments. Given the actions to date and before any pricing, Diageo expects to be able to mitigate around half of this impact on operating profit on an ongoing basis.

The FY2026, given a continued challenging market Diageo expects organic sales growth to be similar to FY2025 (i.e. +1.7%). This is in line with the current market forecast. Growth will be more weighted to the second half, with organic net sales down slightly in the first half. Organic operating profit growth is expected to be mid-single-digit and will be supported by cost savings from the Accelerate programme. This includes the impact of tariffs as at this time. Guidance is slightly better than the current market forecast profit growth of 2.6%. Again, performance will be skewed to the second half. Free cash flow is expected to rise from $2.7bn to $3.0bn, including the exceptional cash cost related to the Accelerate programme.

Source: Bloomberg