As we expected, spirits giant Diageo reported soft full-year sales as the weak global economy led to increased trading down, but this was more than offset by the firm's cost-cutting initiatives, leading to underlying margin expansion. On an underlying internal basis, operating profit grew 4%, in line with our forecast for the year and at the low end of management's previous guidance. However, management offered only a modest outlook for the next fiscal year, guiding underlying internal operating profit growth in the low single digits. We are standing pat on our fair value estimate, as our slightly lower outlook for fiscal 2010 is offset by cash earned during the year.
Underlying internal net sales for the year declined in regions we expected, like Asia Pacific and Europe, but profit margins expanded. The decline in ready-to-drink spirits following the huge excise tax increase in Australia contributed to an 11% decline in volume for the Asia Pacific segment, but segment operating profit was flat. In Europe, steep volume declines in Spain (down 21%) and other regions led to a 6% decline in volume but only a 1% decline in operating profit for the segment. This disciplined cost management allowed the firm to generate free cash flow at a respectable 13% of sales for the year.
For fiscal 2010, we expect Diageo to deliver a solid performance despite a weak consumer environment in Europe and North America, which will weigh on sales for premium spirits. Latin America continues to grow, as volume for the year was up in Brazil, Mexico, and Venezuela, and Africa continues to be strong (net sales were up 16% for the year). In addition, the firm announced another round of cost-cutting in July. Management is guiding for underlying internal operating profit growth in the low single digits next year, slightly below our initial expectations of 4.5%-5.0%, but up nonetheless. The shares continue to trade at a discount to our fair value estimate.
In our opinion, Diageo is the best spirits company on the planet. With eight of the world's top 20 brands and unrivaled global distribution scale, the firm generates robust free cash flows and has a wide economic moat, in our opinion. For an explanation of how Morningstar measures moats, click here.
