Market news and results from BP and Diageo.

Market News 

US equity markets ticked higher last night – S&P 500 (+0.2%); Nasdaq (+0.2%) – marking their longest streak of monthly gains in two years. Investors will now look ahead to big-tech earnings and economic data releases later in the week for direction. The 10-year Treasury currently yields 3.97%, while gold is $1,955 an ounce.
 
This morning in Asia, markets were mixed after lacklustre economic data: Nikkei 225 (+0.9%); Hang Seng (-0.6%); Shanghai Composite (flat). China’s Caixin manufacturing PMI fell to a six-month low of 49.2 in July, worse than estimates and entering contractionary territory for the first time since April. Adding to the pain, the value of China’s home sales plummeted 33% year on year. The nation’s faltering recovery rippled through North Asia, as Taiwan’s PMI slid to an eight-month low, and Japan’s also dipped. However, foreign investors are returning to China’s stock market en masse, signalling a bullish shift in sentiment after months of skepticism.
 
The FTSE 100 is currently little changed at 7,706. HSBC announced a fresh share buyback worth up to $2 billion. Pretax profit rose to $8.8bn, surpassing the $8.0bn estimate. The lender’s dividend payout ratio is 50% for this year and next and it raised its full-year 2023 guidance for net interest income to more than $35bn.
 
Prices in UK stores fell for the first time in two years, another sign the cost-of-living crisis is easing. The BRC said shop prices were 0.1% lower in July than June, with the annual rate of increase dipping to 7.6% from 8.4%. House prices dropped 0.2% month on month and 3.8% year on year in July, data from Nationwide show. Sterling currently trades at $1.2826 and €1.1683.
 
US crude demand jumped to just under 21m barrels per day in May, the highest-ever seasonal level, the EIA said.  Meanwhile, production in Texas, which accounts for about 40% of the country’s output, surged to a record 5.5m b/d. Brent Crude currently trades at $84.90 a barrel.

Source: Bloomberg

Company News - BP

BP has this morning released its Q2 results. As expected, profitability was well below last year. However, the group increased its dividend and committed to buying back another $1.5bn of its shares during the current quarter. In response the shares are up 2% in early trading.

BP is gradually transforming into an integrated energy company. By the end of the decade, it aims to have built out a portfolio of transition growth engines (TGEs), with investment expected to reach $7bn-$9bn a year in 2030. Half will be invested where BP has established businesses, capabilities, and track record – bioenergy, convenience, and EV charging – with the other half in hydrogen and renewables & power. EBITDA (i.e., cash profit) from TGEs is expected to grow to $3bn‑$4bn in 2025 and $10bn-$12bn in 2030 (c. 20% of group profit).
 
BP is not abandoning hydrocarbons. Instead, it is ‘high-grading’ its business towards a focused portfolio of resilient high-quality oil and gas projects that generate premium free cash flow. Investment is being increased by $1bn a year, or up to a cumulative $8bn to 2030. This will help to meet near-term demand for secure supplies of oil and gas, generating additional earnings that can further strengthen BP and support investment in its green transition. The incremental investment will target shorter-term, fast-payback projects that maximise value and deliver rapidly with minimal new infrastructure. Oil and gas production will be around 2.3m barrels a day in 2025 and 2.0m b/d in 2030, 25% lower than in 2019.
 
The overall investment of $14bn-$18bn a year includes acquisitions, providing some reassurance the company won’t engage in large-scale, value-destroying M&A. As a result of this, and an increase in assumptions for oil and gas prices and refining margins, the company is targeting group EBITDA of $46bn-$49bn in 2025 and $51bn-$56bn in 2030 in a $70/barrel oil price environment, and a return on average capital employed of over 18%.
 
In the three months to 30 June 2023, underlying replacement cost profit – the key measure of the group’s performance – fell by 69% to $2.6bn and was below the market forecast of $3.5bn. The decline compared to the same quarter last year reflects significantly lower realised refining margins, a significantly higher level of turnaround and maintenance activity, a weak oil trading result, and lower oil and gas price realisations. Upstream production rose by 3.4% in the quarter to 2.3m b/d.
 
Cost discipline remains very strong – in the first half, upstream production costs fell 9.1% – as does operational performance in terms of upstream plant reliability (95.0%) and refining availability (95.9%).
 
The group advanced two major hydrocarbon projects – Mad Dog Phase 2 in the Gulf of Mexico and the KGD6-MJ gas project offshore India. Momentum in low carbon areas continued – during the quarter, the group completed the acquisition of TravelCenters of America, one of the country’s leading full-service travel centre operators, to complement its convenience and mobility business, and made significant progress growing its pipeline of hydrogen projects.
 
Operating cash flow fell by 42% to $6.3bn, including $1.2bn of Gulf of Mexico oil spill payments within a working capital release of $0.1bn. The group also received $88m of disposal proceeds from non-core assets, leaving it on track to hit $25bn by 2025. Capital expenditure was $4.3bn in the quarter (including $1.1bn of M&A), on track for the $16bn-$18bn full-year target. Net debt rose slightly to $23.7bn, with gearing at 21.7%, and the group remains committed to maintaining a strong investment grade credit rating.
 
The company allocates around 40% of its surplus cash flow to further strengthening the balance sheet and maintaining a resilient cash balance point of around $40 per barrel Brent oil price. This provides the capacity to grow its dividend by around 4% a year at around $60/barrel. In addition, the company is committed to allocating 60% of surplus cash flow to share buybacks, equating to $4bn a year at $60/barrel at the lower end of its capital expenditure range, with the prospect of more in a higher price environment. Note the current price is $85/barrel.
 
Today, the group has declared a quarterly dividend of 21% higher than last year. A similar payout for the full year would equate to a 4.6% yield at the current share price and currency rate. The $1.75bn quarterly share buyback programme announced with the Q1 results was completed earlier this week. Over the last four quarters, the company has completed over $10bn of buybacks from surplus cash flow and reduced its issued share capital by over 9%. Today the group has announced a further $1.5bn buyback even though there wasn’t any surplus cash flow generated in the quarter.
 
In the current quarter, the group expects oil prices to be supported by seasonal demand and the OPEC+ production restrictions, while industry refining margins are expected to remain above historical average levels, supported by low product inventories and seasonal demand in the US. For the full year, the company now expects its reported and underlying upstream production to be higher than in 2022.
 
We believe decarbonisation can’t happen at the flick of a switch – oil and gas will remain part of the global energy mix for decades, with demand driven by population growth and higher incomes, particularly in developing countries where the desire for energy intensive goods and services like cars, international travel, and air conditioning is rising. We also believe the production of the materials needed to transition to net zero can’t happen without using hydrocarbons. At the same time, reduced investment in new production, partly because of environmental concerns, is increasingly leading to constrained supply. Clearly, events in Ukraine have further exacerbated the long-term supply backdrop at a time when there is increased demand for secure and affordable energy.
 
Against this backdrop, BP is looking to reduce emissions in a way that delivers attractive returns for shareholders at a time of macroeconomic uncertainty. Although execution of the group’s low carbon strategy, particularly in terms of capital discipline, will have some impact on the share price, far more important in the medium term will be commodity prices and cost cutting, and the cash flow and shareholder returns generated as a result.
 
Despite strong performance over the last two years, the shares remain on an undemanding valuation, both in absolute terms and relative to the US majors, which fails to consider the potential for free cash flow generation and shareholder returns.

Source: Bloomberg

Company News - Diageo

Diageo has this morning released robust results for the financial year to 30 June 2023, delivering sales and profit growth with its medium-term guidance. The company has announced a new share buyback programme, and in response its shares have been marked up by 2% in early trading.
 
Diageo is a leading global drinks company, with a unique portfolio of iconic brands including Johnnie Walker, Smirnoff, Captain Morgan, Baileys, Tanqueray, and Guinness. The group is an integrated operator, producing and supplying drinks at a variety of price points across strong global distribution routes. In the long term, we believe Diageo is well placed to benefit from the trend towards premiumisation – including its 34% stake in Moet Hennessey, the group generates more than half of its sales from high margin, premium brands. In addition, product innovation and effective marketing allow Diageo to get ahead of consumer trends and drive sales growth. The group has a strong presence in the under-penetrated emerging markets, where the number of people of legal purchasing age is set to increase by over 450m over the next decade. Wealth is also increasing in these regions, with the middle class expanding and consumers shifting from local products to higher-margin premium international brands.
 
The group believes its sales growth trajectory has accelerated, underpinned by the strength of its advantaged position across geographies, categories, and price tiers. Management is confident it can grow Diageo’s value share of the total beverage alcohol market from 4% in 2020 to 6% by 2030 and is now targeting organic net sales growth of 5% to 7% for FY June 2023 to FY2025 (vs. 4% to 6% in FY17 to FY19). We believe this sales target could prove to be conservative.
 
Although inflationary pressures remain, ownership of premium products with high gross margins makes it easier to push through price increases. As a result, management expects organic operating profit to grow sustainably in a range of 6% to 9% in FY23-FY25 (i.e., a gradually expanding margin). Under the leadership of new CEO Debra Crew, we don’t expect any strategic change in the near term.
 
In the year to end June 2023, reported net sales grew by 10.7% to £17.1bn. Organic net sales (which excludes M&A and currency impact) grew by 6.5%, in line with the consensus forecast of 6.4%. This was despite the group facing a very strong year-on-year comparative – FY2022 was up 21.4%.
 
Price/mix grew 7.3%, reflecting a high single-digit contribution from price and premiumisation. Despite the price increases, organic volume only fell by 0.8%. Net sales are now 35% ahead of 2019 (i.e., pre-pandemic).
 
The group continued to optimise its portfolio through acquisitions – Mr Black (coffee liqueur), Balcones Distilling (American single malt whisky), and Don Papa rum – and disposals (Guinness Cameroon, Archers and a portfolio of brands in India).
 
Broad-based growth was enjoyed across most categories, particularly in tequila (+19%), scotch (+12%), and beer (+9%). Premium-plus brands contributed 63% of reported net sales and drove 57% of organic net sales growth. Total trade market share grew or remained stable in over 70% of total net sales value in measured markets – an impressive performance.
 
The group enjoyed strong growth in four of its five regions. In North America, the group’s largest market, organic sales were flat. Although the group faced a tough comparison with last year’s 14% growth, the region delivered a stable performance as the US spirits industry, as expected, continued to normalise post-pandemic. Elsewhere: Europe (+11%); Africa (+5%); and Latin America & Caribbean (+9%); and Asia Pacific (+13%).
 
Operating profit grew by 7.0% in organic terms to £4.6bn, slightly ahead of the market forecast for 6.3% growth. The margin grew by 15bps in organic terms to 27.1%, driven by disciplined cost management. Price increases more than offset the absolute cost inflation impact on gross margin and the group increased organic marketing investment by 5.6%, reflecting investment in its brands. Adjusted EPS grew by 7.6% to 163.5p, just below the consensus forecast of 165p.
 
Free cash flow fell from £2.8bn to £1.8bn as strong growth in operating profit and favourable foreign exchange impacts were more than offset by higher (more normalised) year-on-year working capital outflows, tax and interest payments, and capital investment. However, the balance sheet remains strong – financial gearing ended the period at 2.6x net debt to EBITDA, at the lower end of the target ratio of 2.5x-3.0x. The dividend was increased by 5% to 80p, to yield 2.4%. The company bought back £1.4bn of its shares during the year and has today announced a new programme of up to $1bn.
 
Looking forward, the group expects operating environment challenges to persist, with continued cost pressure and ongoing geopolitical and macroeconomic uncertainty. In the first half of fiscal 24 (to December 2023), despite a tougher comparator, the group expects gradual improvement from the second half of FY2023. Organic net sales growth is then expected to accelerate in the second half of fiscal 24 (to end June 2024), given the softer comparator. The group expects organic operating margin to benefit from premiumisation trends and operating leverage while investing strongly in marketing. Organic operating profit growth in FY2024 is also expected to improve from the second half of FY2023 and accelerate gradually through FY2024. We note the company compiled consensus is for 5.7% organic sale growth and 6.9% organic operating profit growth, implying a slight margin expansion.
 
The group has reiterated its medium-term guidance for FY23 to FY25 of consistent organic net sales growth in the range of 5% to 7% and sustainable organic operating profit growth in the range of 6% to 9%.
 
Starting from the current financial year, in line with reporting requirements the functional currency of Diageo has changed from sterling to the US dollar. Diageo has also changed its presentation currency to US dollar.
 
Overall, as an affordable luxury, we believe spirits are recession-resilient, not recession proof, with earnings potentially affected by downtrading and destocking. However, Diageo is better positioned today than in the past to navigate a more challenging external environment because of its strong portfolio, improved commercial execution, and controlled inventory strategy.

Source: Bloomberg