Best International Stock: Diageo

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Here's the investing word for today, boys and girls. It stems from the Latin word dies, meaning "day," and the Greek word geo, meaning "from Earth."

Diageo. Here's how your pronounce it: Dee-AHH-jee-o.

Hmm. You're not convinced this has anything to do with investing. Fair enough. How about these, then?

  • More top-20 liquor brands than the next five competitors combined
  • $14 billion in worldwide revenues
  • More than $3 billion in operating cash flow per year
  • 3.5% dividend

Ah, so those got your attention, did they? Good, because they basically describe Diageo, a London-based seller of liquor, beer, and wine, and my entry into the Fool's Best International Stock contest.

In fact, when surveying the landscape of large-cap international companies, Motley Fool Income Investor pick Diageo (NYSE: DEO  ) is probably the very first one investors should consider. I really like the economics of the spirits business, and I think Diageo is well-positioned to continue its top-shelf performance.

The business and the brands
Diageo is the world's largest spirits seller. Brands like Smirnoff, Johnnie Walker, Baileys, Captain Morgan, J&B Whiskey, Jose Cuervo, and Tanqueray line the company's liquor cabinet, contributing more than half of the company's unit volumes. Diageo also has a few beer and wine brands, of which the most popular is Guinness. The London-based company sells its alcoholic beverages all over the world, but North America and Europe make up almost 75% of Diageo's volumes.

Put it this way: If you're traveling anywhere in the world and you can find a pub, chances are that you can relax with a Guinness or a Tanqueray martini. And while the likes of Motley FoolInside Value pick Anheuser-Busch (NYSE: BUD  ) , InBev, and SABMiller sell far more beer around the world, no one can touch Diageo when it comes to pitching us gin, vodka, and scotch -- not even the newly combinedAllied Domecq-Pernod Ricard combo.

But Diageo's strength also comes from the managers who sit in the boardroom.

The British are coming!
In August of last year, the company liquidated its remaining 7% stake in General Mills (NYSE: GIS  ) and refinanced some debt related to the divesture of Burger King in 2002. The company is now finally removed from the cereal and burger businesses.

Why is this important? In a word: focus. Diageo management is now fully dedicated to building and strengthening its adult beverage brands. When companies stick to what they know, good things can happen.

We also have to credit management for using Diageo's cash flow to buy back loads of stock. Over the six months ending last December, Diageo repurchased around $1.2 billion worth of shares, reducing its average share count by almost 4%.

Operationally, Diageo seems to be moving along very nicely, although Europe continues to be challenging. Just yesterday, the company announced first-half results for fiscal year 2006. Volumes moved up 5%, while net sales increased 8%. Smirnoff Vodka and Johnnie Walker, Diageo's two best-selling brands, generated double-digit sales growth. Operating profit expanded 8%, while EPS based on IFRS accounting standards grew 11%, reflecting the share buybacks.

The Foolish bottom line
So Diageo has the brands, the management, and the focus. But how does the stock look?

The ADRs increased around 5% in 2005. While not as cheap as they were in late summer, when Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) insurance subsidiaries picked up 15 million shares, I still think the shares have some room to grow.

The stock sells at a P/E of around 16 times this year's earnings, and the company delivers returns on capital in the mid-teens (up from 10% a few years ago). Both metrics are comparable to peers like Anheuser-Busch, Brown-Forman (NYSE: BFB  ) , and Constellation Brands (NYSE: STZ  ) .

But these companies just can't compare to the liquor brands that Diageo brings to its wholesalers. In fact, Morningstar reports that 80% of Diageo's U.S. distributors exclusively sell Diageo brands. Now that's brand power -- and a huge competitive advantage that will serve the company well over the next five years.

With its 3.5% yield, growing operating earnings, and a willingness to buy back shares, Diageo has demonstrated that it can deliver for shareholders. If you're looking to wet your beak with an international stock, Diageo could be your cup of Tanqueray.

Check in with the other competitors:

Diageo is an Income Investor pick, and Anheuser-Busch is an Inside Value pick. Try out the newsletter that best fits your investing style with a 30-day free spin.

Motley Fool research analyst Andy Cross enjoys his Tanqueray martinis with an odd number of olives, please. At the time of publication, he owned shares in Berkshire Hathaway, but held no financial position in any other company mentioned. The Fool has a disclosure policy.


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