Morning Note: Market news and updates from Diageo and Becton Dickinson.

Market News

US equity markets moved lower last night – S&P 500 (-0.8%); Nasdaq (-0.9%) – after Federal Reserve Chair Jerome Powell warned interest rates may have to climb further. He said he won’t hesitate to raise rates again if needed to contain inflation. He also said the Fed will “continue to move carefully.” Interim St. Louis chief Kathleen Paese said it’s important for policymakers to have the option to hike further. Credit risk will replace interest-rate risk as the market’s “big fear” next year, Mohamed El-Erian said. The recent rally in bonds also faltered, with the 10-year Treasury yield moving back up to 4.61%. Gold fell to $1,954 an ounce.

This morning in Asia, markets were also weak: Nikkei 225 (-0.2%); Hang Seng (-1.6%); Shanghai Composite (-0.5%). The FTSE 100 is currently trading 0.5% lower at 7,412.

UK GDP unexpectedly rose 0.2% in September, leaving economic growth flat in the third quarter. Economists had predicted zero expansion for the month. The pound rose briefly as the economy continued to defy predictions of a recession. Sterling currently trades at $1.2220 and €1.1460.

Jeremy Hunt will have about £10bn less for public services in his autumn statement as a result of the Bank of England’s sales of government bonds, economists calculate. Unlike other G-7 central banks, the BOE’s QT program involves active selling, as opposed to shrinking balance sheets by allowing securities to mature and roll off. The BOE wants to act quickly to get rid of a government indemnity, because it raises questions about its independence.

Oil trades at $80.30 a barrel and is headed for its third weekly drop. The recent plunge is unwarranted and prices may find support on reduced supply and potential bottlenecks in the Persian Gulf, Phillip Nova said. In Asia, front-month time spreads for diesel are signalling more bearishness.

Source: Bloomberg

Company News

Diageo has this morning released an unscheduled trading update which highlights that due to materially weaker performance outlook in its Latin America and Caribbean region, the group now expects to see slower growth in the six months to 31 December 2023 than in the previous six months. In response, its shares have been marked up by 10% 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 is targeting annual organic net sales growth of 5% to 7%, underpinned by the strength of its advantaged position across geographies, categories, and price tiers. The aim is to increase its value share of the total beverage alcohol market from 4.7% in 2023 to 6% by 2030.

At the time of its last trading statement in September the group stated that it expected to see a gradual improvement in organic net sales growth in the six months to 31 December 2023 (i.e., H1 FY2024) versus the previous six months (i.e., H2 FY2023).  

However, in today’s statement, the group highlights that it now expects to see slower growth than in the previous half-year. This is due to a materially weaker performance outlook in Latin America and Caribbean (11% of group sales), which is now expected to see a decline in organic net sales by more than 20% year-on-year in the current half-year.

Although the region is facing a tough year-on-year comparative, the downturn is being driven by macroeconomic pressures resulting in lower consumption and consumer downtrading. These impacts are slowing down progress in reducing channel inventory to appropriate levels for the current environment. Despite slowing category growth, Diageo continues to win share in most markets, within the categories it participates in. The main disappointment is that the company had previous highlighted that a shift to a ‘sell-out’ model was meant to provide greater visibility over the supply chain – this is clearly not the case in the LAC region at present. Remedial actions are currently being undertaken but the speed of the deterioration is a concern.

Encouragingly, in the group’s other regions trading is generally resilient. In the key North America market, the group still expects gradual improvement in organic net sales growth in the current half-year versus the previous half-year (albeit still a decline). Elsewhere, momentum is continuing, albeit with uncertainty in the Middle East and a slower than expected recovery in China.

Overall, the group now expects organic operating profit in the current half-year to decline year-on-year. Looking ahead to the second half of FY2024 (i.e., the six months to June 2024), at the group level, the company expects to see a gradual improvement in organic net sales and organic operating profit growth from the first half while it continues to invest in marketing, and in the business, to drive long-term sustainable growth. 

The group continues to believe in the fundamental strength of the business and expects to deliver its 5% and 7% target over the medium term. The group plans to expand on its confidence in its guidance at its Capital Markets Event next Wednesday.

In the near term, Diageo expects operating profit to grow broadly in line with organic net sales growth, while brand investment continues. Over time, as inflation moderates and productivity from the group’s cost cutting programme flows through, the company expects operating profit to grow ahead of organic net sales growth. However, on the analysts’ call, management were unwilling to provide precise timing on when margin expansion would resume.

The group’s balance sheet remains strong – financial gearing ended the last financial year 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%, and the company is undertaking a share buyback programme of up to $1bn.

Source: Bloomberg

Yesterday lunchtime, Becton Dickinson released its results for the financial year to 30 September 2023 which were in line with market expectations. Guidance for FY2024 was below current market forecasts and in response the shares were marked down by 9% during US trading hours.

Becton Dickinson (BD) is a leading global supplier of medical devices and instrument systems. The group’s products help achieve better healthcare outcomes, mitigate healthcare cost pressures, and improve healthcare safety. 90% of revenue comes from products where the group is the market leader, with 85% from recurring or non-capital related purchases. As a result, the company is well placed to benefit from increased demand for healthcare from an ageing population and in emerging markets. In the near term, revenue growth will be, in part, dependent on improving patient admissions and surgical volumes and a stable capital investment environment.

The group’s BD 2025 Strategy is targetting sustainable mid-single-digit revenue growth (i.e., 5.5%+), margin expansion of 540bps (to 25%), and double-digit earnings and free cash flow growth. The group is actively managing its portfolio – Embecta, the diabetes care unit, has been spun off into a separate public company and the Surgical Instrumentation platform in the Surgery business has been sold for $540m. In addition, the exit of lower margin products and markets has seen 2,300 stock lines removed, with the number of SKUs expected to be 20% lower by 2025. The result is a more simplified portfolio and increased efficiency able to drive improved operating leverage.

During the year, revenue from continuing operations grew by 4.5% on a currency-neutral basis to $19.4bn. In the final quarter, revenue was up 5.9% on a currency-neutral basis to $5.1bn, a touch ahead of the market expectation of $5.0bn.

Base revenue, which strips out Covid-only testing, grew by 7.0% on a currency-neutral basis, versus the company’s guidance of 6.8%-7.1%, and well above the medium-term target. Organic growth (i.e., excluding acquisitions) was 5.8%, versus company guidance of 5.65%. In the final quarter, Base revenue was up 6.3%, with organic growth of 7.0%, versus guidance of 6%.

By region, quarterly growth in the US (+6.3% to $2.9bn) outpaced the International business (+5.3% to $2.2bn). y division, BD Medical (50% of sales) grew by 6.2%. BD Life Sciences (26% of sales) was up 2.2% but was up 3.8% excluding the reduced contribution from COVID-19 diagnostic testing revenue. BD Interventional (24% of sales) was up 9.6%.

Over the last couple of years, the group has acted early to deal with rising input inflation and supply chain issues. The full-year gross margin rose by 10bps at constant currency to 53.5%, despite the 200bps impact of inflation. The operating margin increased by 110bps at constant currency to 23.5%, versus guidance to grow by at least 100 bps to 23.6%.

Full-year adjusted EPS grew by 11.0% on a currency-neutral basis to $12.21, versus the group’s guidance range of $12.10 to $12.32. In the final quarter, EPS grew by 25% on a currency-neutral basis to $3.42, in line with the market forecast of $3.43.

The group generated $2.1bn of free cash flow (+41%) to leave financial gearing at 2.6x net debt to EBITDA, a touch worse than the target of 2.5x. Cash flow is being directed to internal growth opportunities, bolt-on M&A, and shareholder returns. The group currently spends around 6% of revenue on R&D, with 60% directed towards what the company calls transformative solutions. The group las launched 52 key new products in the past two years and is on track to launch 100 products through to 2025, generating incremental revenue of $1.7bn versus $0.8bn in 2020. In the latest quarter, the group launched its next-generation needle-free blood draw technology and received regulatory clearance for a single molecular diagnostic combination test that identifies and distinguishes COVID-19, Influenza A/B and RSV.

The group also plans to deploy $1.5bn-$2.0bn per year on tuck-in acquisitions. A progressive dividend policy has been maintained for the 52 consecutive years, with the annual dividend rate of FY2023 up 4.6% to $3.64 per share. The indicated annual rate for FY2024 is $3.80, up 4.4%, and equal to a yield of 1.6%.

During the summer, Becton received FDA clearance for its Alaris Infusion System, a product that had to be removed from the market in 2020 following a call for more information on the product software upgrade. The group will gradually return to full commercial operation with an enhanced and updated market-leading system that can safely deliver medications, fluids, and blood products to support patient care. Shipping of updated devices began at the end of September.

The group fleshed out its full-year guidance for FY2024:

-          Base organic revenue is expected to grow by between 5.25% and 6.25% to $20.1bn-$20.3bn. This includes a headwind of over 25 basis points from the expected decline in COVID-only diagnostic testing.

-          The operating margin is expected to grow by 50bps with a flat gross margin and positive SG&A leverage.

-          Adjusted EPS is expected to grow by between 8.25% and 10.25% on a currency-neutral basis to $12.70-$13.00. This includes absorbing an estimated 75bps negative impact from the divestiture of the Surgical Instrumentation platform to give ‘operational’ growth of 9%-11%.

Before the release of the results, the market forecast stood at $13.50, 5% above the guidance midpoint of $12.85, however this has been muddied by 375bps of negative currency impact. It is also unhelpful that FY24 is expected to get off to a slow start (i.e., the three months to 31 December), albeit made up for during the rest of the year. Organic revenue growth expected to under-index the full-year by over 200 bps driven by a tough comparative base and market dynamics in China. The operating margin is expected to fall by 350bps during the quarter driven in part by the negative absorption from planned and executed inventory reductions.

Source: Bloomberg