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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 scenario at Diageo is totally different, there are clear challenges.
Diageo’s difficulties
Diageo’s essential situation has been weak demand for its product. Slicing the dividend received’t have an effect on this immediately, nevertheless it may restrict the impact on the corporate’s steadiness sheet.
The agency completed its 2025 monetary yr with a leverage ratio of three.4, which is each excessive and above its goal vary. However there are a couple of methods for attempting to deliver this again down.
Ideally, the way in which to do that is by rising earnings, however that’s simpler mentioned than finished. The explanation the ratio is excessive is that money earnings have been falling not too long ago, for a wide range of causes.
The choice is to pay down debt. And one approach to increase money for that is by promoting a number of the agency’s weaker traces to give attention to its stronger ones – a transfer Lewis efficiently executed at Tesco.
Basically, although, it’s greatest to be promoting from a place of power. So whereas it’d work, I feel buyers needs to be alert to the opportunity of 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 due to this fact assume there’s a menace to Diageo’s dividend that’s value 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 earnings. However for my part, even those that are ought to view strengthening the corporate’s monetary place as a long-term optimistic.
If Diageo’s dividend will get reduce, shareholders can nonetheless generate earnings by promoting a part of their funding. The truth is, they may even be higher off on this scenario.
The inventory at present 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 present have a alternative between getting £1 in money as a dividend or promoting £1 in fairness for £4. So there’s nonetheless an excellent earnings alternative there for buyers.
Finally, the agency must get its earnings transferring in the proper path. That’s what is going to matter for shareholders, far more than the mechanism by which they generate returns.
Chasing shadows
I feel worrying in regards to the viability of Diageo’s dividend is a bit like me worrying that my shadow appears prefer it’s placing on weight. It’s not an amazing signal, nevertheless it’s probably not the issue.
The underlying situation for the corporate is a requirement problem. And this issues far more than whether or not the agency cuts or sustains its dividend.
No matter dividend coverage, buyers will have the ability to discover methods of producing earnings if Diageo does effectively. The massive query is whether or not the brand new CEO can flip issues round.
