Peter Clowes and Andrew Corwin

What is Diageo (DEO)?

• Diageo is the largest premium spirits company in the world with control of 8 of the top 20 liquor brands.

• Diageo has a market cap of $27.05 Billion.• Diageo has the largest global presence and

established distribution system among premium liquor companies.

• Diageo’s high end, branded products yields impressive profit margins.

• Best of all, Diageo is undervalued:– Price per share: $41.14 (as of 3/9/09)– Fair Value Estimate: $78.28

Diageo’s Top Global Brands

A Socially Responsible “Sin” Stock

• Social Sustainability– 110 responsible drinking programs in 45

countries– 1.1% of Operating Profit donated annually to

direct investment in local communities• Environmental Sustainability

– Goal: Reduce company wide emissions by 5%– Goal: Reduce non-ingredient water used by

50%– 95% of solid waste was reused/recycled in

past year, goal of 100% by 2015

TTM Performance:

Holding Period Performance:

Industry Overview

• In the premium spirits sub-industry, Diageo is the current market leader.

• This sub-industry is highly competitive due to the lucrative margins it generates.

• There can only be a limited number of “premium” brands.

• Distribution and Brand Equity are crucial.

Porter’s Five Forces:

Ratio AnalysisDiageo (DEO)

Brown-Foreman (BF.A)

Constellation Brands (STZ)

CEDC (CEDC)

Mkt. Cap 34.97B 7.69B 3.43B 0.64B

P/E Ratio 11.75 17.22 (4.71) 5.73

EPS $4.73 $2.96 ($3.33) $2.41

Dividend Yield

4.83% 2.13% 0% 0%

Dividend Payout Ratio

57.32% 81.06% 0% 0%

ROE .36 .26 (.26) 0.14

NI/Sales .18 .17 (.19) 0.09

Valuation Overview:

Growth Forecast

RegionProjected

GDP Growth DEO Growth% of Total

SalesWeighted

Contribution

N. America 2.3% 3.1% 28.1% 0.9%

Europe 3.2% 3.2% 38.3% 1.2%

Asia / Pacific 6.5% 6.0% 11.1% 0.7%

International 4.7% 7.0% 22.5% 1.6%Total DEO Growth: 4.34%

*Source: IMF (www.imf.org)

Profitability: Key Drivers

• Premium Products: – High Brand Loyalty– High Margins– Unique

• Distribution Network: – Efficient Distribution Creates

Competitive Advantage– Exclusive Distribution Rights Among

Vendors

Profitability: Margins

• Combining DEO’s growth with its key drivers results in sustainable and defensible profit as evidenced by these margins:– 3-yr Trailing Average Gross Margin: 63%– 3-yr Trailing Average Operating Margin:

28%– 3-yr Trailing Average Profit Margin: 21%

FCF Generation2006 2007 2008 2009 2010 2011

Net Income

$3,528 $2,709 $2,976 $3,613 $3,479 $3,734

Free Cash Flows

$1,226 $1,514 $1,179 $2,042 $2,745 $2,702

FCF/NI 35% 56% 40% 57% 79% 72%

Access to FCF2006 2007 2008 2009 2010 2011

Net Income

$3,528 $2,709 $2,976 $3,613 $3,479 $3,734

Free Cash Flows

$1,226 $1,514 $1,179 $2,042 $2,745 $2,702

Dividends

$1,598 $1,721 $1,706 $1,780 $1,860 $1,946

Divs/FCF 130% 114% 145% 87% 68% 72%

Stock Buyback

$3,329 $4,388 $4,737 - - -

Price Per Share

$60.85 $77.60 $71.03 $80.74 $90.56 $101.08

*Prices in Millions USD (Except Per Share Data)

Valuation

• Target Price: $78.31• Price as of 3/31/09: $44.75• Model Outputs:

– Model Implied Price 6/30/08: $71.04– Actual Price for 6/30/08: $71.03

• Per Share Value of Future Dividends: $76.19 (Discounted by Ke at 8.71%)

Methodology

• Growth Forecast: 4.34% fading to 5% after five years.

• WACC: 7.69%– Risk Free: 3.25% (adjusted by 50 bps)– Cost of Debt: 7.95%– Cost of Equity: 8.71%– Beta: .77

Risk Analysis

• Currency exposure due to recent depreciation of the British Pound versus the U.S. Dollar.

• When the U.S. enters an inflationary period, due to the large amounts of cash being injected into the economy, Diageo will be protected.

• Economic slowdown may result in less high end purchases.

• Consumers may trade down, but historically, premium spirits are resilient. Scotch and whiskey have seen an increase during this economic cycle.

Sensitivity Analysis:

COGS Sales

  +10% +5% Constant -5% -10% -20%

Constant $95.93 $86.74 $78.34 $70.67 $63.68 $51.58

+5% $92.62 $83.69 $75.52 $68.09 $61.32 $49.62

+10% $89.31 $80.63 $72.71 $65.51 $58.96 $47.67

+15% $85.99 $77.57 $69.90 $62.92 $56.60 $45.71

*The percent changes in this analysis are deviations from near term starting rates. Long term values are held constant. Prices are per share values.

Diageo’s Value Proposition:

• Sustained Growth and Aggressive Growth Opportunities

• Defensible Profit Margins• Stable Earnings and High FCFs• Actual Return of FCFs to

Shareholders• Highly Undervalued

Questions?