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Diageo (LSE:DGE) shares responded positively to the appointment of Dave Lewis. However I feel buyers ought to begin planning for a dividend reduce.
When Lewis took over at Tesco in 2014, the agency suspended its dividend and it didn’t return till 2018. And whereas the state of affairs at Diageo is completely different, there are clear challenges.
Diageo’s difficulties
Diageo’s important difficulty has been weak demand for its product. Slicing the dividend gained’t have an effect on this immediately, however it might restrict the impact on the corporate’s steadiness sheet.
The agency completed its 2025 monetary 12 months with a leverage ratio of three.4, which is each excessive and above its goal vary. However there are a couple of methods for making an attempt to deliver this again down.
Ideally, the best way to do that is by rising earnings, however that’s simpler mentioned than carried out. The rationale the ratio is excessive is that money earnings have been falling lately, for quite a lot of causes.
The choice is to pay down debt. And one technique to elevate money for that is by promoting a number of the agency’s weaker traces to concentrate on its stronger ones – a transfer Lewis efficiently executed at Tesco.
Normally, although, it’s greatest to be promoting from a place of power. So whereas it would work, I feel buyers must be alert to the potential for motion across the dividend.
Within the context of £16.56bn in internet borrowings, £1.75bn in annual dividends isn’t going to make an enormous distinction. However as they are saying at Tesco, each little helps.
Ought to buyers fear?
I subsequently suppose there’s a menace to Diageo’s dividend that’s price taking very significantly at this level. However I’m a shareholder and I don’t see this as one thing to fret about.
That’s partly as a result of I’m not counting on the inventory for revenue. However in my opinion, even those that are ought to view strengthening the corporate’s monetary place as a long-term constructive.
If Diageo’s dividend will get reduce, shareholders can nonetheless generate revenue by promoting a part of their funding. In reality, they could even be higher off on this state of affairs.
The inventory at the moment trades at a price-to-book (P/B) ratio of 4.6. In different phrases, each £1 the agency retains on its steadiness sheet interprets into £4.60 in market worth.
Given this, buyers at the moment have a selection between getting £1 in money as a dividend or promoting £1 in fairness for £4. So there’s nonetheless a great revenue alternative there for buyers.
In the end, the agency must get its earnings transferring in the fitting route. That’s what is going to matter for shareholders, way more than the mechanism by which they generate returns.
Chasing shadows
I feel worrying concerning the viability of Diageo’s dividend is a bit like me worrying that my shadow appears to be like prefer it’s placing on weight. It’s not an incredible signal, however it’s probably not the issue.
The underlying difficulty for the corporate is a requirement problem. And this issues way more than whether or not the agency cuts or sustains its dividend.
No matter dividend coverage, buyers will be capable of discover methods of producing revenue if Diageo does properly. The massive query is whether or not the brand new CEO can flip issues round.
