Peter Clowes and Andrew Corwin

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• Peter Clowes and Andrew Corwin

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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.
• Diageos 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

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Diageos Top Global Brands

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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

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TTM Performance
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Holding Period Performance
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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.

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Porters Five Forces
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Ratio Analysis
Diageo (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
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Valuation Overview
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Growth Forecast
Region Projected GDP Growth DEO Growth of Total Sales Weighted 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 Total DEO Growth 4.34
Source IMF (www.imf.org) Source IMF (www.imf.org)
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Profitability Key Drivers

• Premium Products
• High Brand Loyalty
• High Margins
• Unique
• Distribution Network
• Efficient Distribution Creates Competitive
  Advantage
• Exclusive Distribution Rights Among Vendors

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Profitability Margins

• Combining DEOs 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

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FCF Generation
2006 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
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Access to FCF
2006 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)
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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)

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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

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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.

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Sensitivity Analysis
COGS Sales Sales Sales Sales Sales 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.
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Diageos 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??

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