Diageo (DEO) is is the largest spirits company in the world with such market-leading brands as Johnnie Walker scotch, Smirnoff vodka, Captain Morgan rum, Gordon’s gin, and Guinness stout, notes Gavin Graham, contributing editor to Internet Wealth Builder.

Over one-third of its revenue comes from faster growing emerging and frontier markets making it an excellent way to play the growth of the middle class in these regions.

In the year ended June 30, Diageo enjoyed a strong recovery from the COVID-19 weakness in the previous year. Reported revenues were up 8.3%, to £12.7 billion, on strong organic growth of 16.6%. That was partially offset by negative foreign exchange effects as the pound sterling strengthened against other currencies.

North America saw particularly strong organic growth of 20.2%, helped by resilient consumer demand, spirits taking market share, and restocking by distributors and retailers. Reported operating profit grew 74.6%, to £3.7 billion, due a significant decline in exceptional items caused by COVID-19.

Organic operating profit increased 17.7% with strong growth in all regions except Europe and Turkey, where beer sales were affected by lockdowns. Net cash generated from operations grew 54%, to £3.7 billion, and free cash flow rose 88%, to £3.0 billion, helped by growth in profits, working capital management and a delayed dividend from 2019 from associates.

Pre-exceptional earnings per share (EPS) grew 7.4%, to £1.17, and Diageo’s leverage ratio of debt to equity was reduced to 2.8 times. The dividend, paid semi-annually, with one-third at the interim and two-thirds at the time of the final result, was increased 5%, to £0.4459 per share, for a yield of 2.3%. Diageo’s 10-year average annual total shareholder return since being recommended has averaged 13%.

Since year end, Diageo has opened the first carbon-neutral whiskey distillery in Lebanon, Kentucky to make Bulleit Bourbon and a $75 million China-origin single malt whisky in Yunnan.

CEO Ivan Menezes indicated that Diageo expected strong organic net sales growth of at least 16% in the first half of 2021-22 and organic operating profit growth ahead of that figure.

The company expects organic net sales growth of 5%-7% for fiscal 2023-25 and organic operating profit growth of 6%-9%, ahead of the 4%-6% organic sales growth in fiscal 2017-19. Diageo has set a target of raising its share of the global total beverage alcohol market to 6% by 2030 from 4% today.

Diageo has risen over 35% since our update in February. I expect to see strong growth this year as it recovers from the effects of COVID-19 and as it leverages both its exposure to rising middle class consumption in emerging markets and premiumization (consumers buying more expensive drinks) in developed markets. It remains a Buy.

Unilever (UL), an Anglo-Dutch food and consumer products company, derives more than 60% of its revenues from emerging and frontier markets, with brands that include Hellmann’s mayonnaise, Ben and Jerry’s ice cream, and Dove shampoo and deodorants.

Unilever moved its corporate headquarters to the UK in 2020 and ended its dual listing structure, partially to avoid the 15% withholding tax levied on non-Dutch shareholders.

In the nine months to Sept. 30, Unilever delivered a better-than-expected underlying sales growth (USG) of 2.5%, although this consisted of 4.1% price increases and a 1.5% drop in volumes, showing the difficulty Unilever has with growing its mature food businesses.

Turnover was up 4% under GAAP rules to €13.5 billion, an improvement over the 1.7% GAAP growth to €39.3 billion for the nine months ending Sept. 30. USG was a healthy 4.4% in the period, and management is confident that USG will be within its indicated 3%-5% range for the whole of 2021. The stock currently yields 3.8%.

Good growth was delivered in Unilever’s three priority markets of the US, India, and China, but Southeast Asia was severely affected by COVID-19 related lockdowns. E-commerce grew 38% for the quarter and is now 12% of total sales. Its high-growth new businesses, prestige beauty and functional nutrition, grew by double digits, and it acquired skin care brand Paula’s Choice.

Inflationary pressures remained high, with CFO Graeme Pithkethly warning that “inflation could be higher next year than this year,” adding it was likely to peak in the first half of 2022. The quarterly dividend remained unchanged at €0.4268, giving a yield of 3.8%. A €3 billion share buyback program will complete by the end of the year.

Continuing the trend of disposing of lower-growth food businesses in developed markets, Unilever just announced the sales of its tea business, which includes such well-known brands as Lipton’s, PG Tips, and Brooke Bond to private equity firm CVC Capital Partners for €4.5 billion with the deal expected to close in the first half of 2022. The business generated sales of €2 billion in 2020, so the price is a reasonable 2.25 times revenues.

Interestingly Unilever is retaining the tea business in India, Nepal, and Indonesia, including its tea plantations as black tea is still a popular and growing segment in these markets. Unilever also retains its joint venture Pepsi-Lipton ready-to-drink tea business with Pepsi.

Unilever is down 5% from our previous update, but with its ability to pass through rising raw material costs and the sale of low growth tea business, its revenues should continue to grow 3%-5% and earnings 5%-6%. It is consequently a Buy for its exposure to the emerging markets’ middle classes and its faster growing personal care business.

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