5 Reasons to Mix This Top-Shelf Stock Into Your Portfolio

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What do a single-malt scotch, a glass of bubbly, and a delicious Zinfandel have in common? Aside from the impending hangover, they're all made by one serious powerhouse of a beverage company. U.K.-based Diageo (NYS: DEO) is the largest spirits and wine company in the world, holding the No. 1 or No. 2 market share in most of its brands. In a mature industry with intense competition and ever-changing consumer preferences, this beverage behemoth stands unswerving for five main reasons.

  1. Diverse source of revenue and profits. Spirits account for 72% of net sales, beer accounts for 22% of net sales, and wine, champagne, and other accounts for 9% of net sales. No individual spirit category makes up more than 27% of Diageo's sales.
  2. Brand recognition and dominance. Eight of the top 20 premium spirits brands are part of Diageo's portfolio. Several of its strategic brands include Smirnoff, Johnnie Walker, Guinness, Baileys, Captain Morgan, Jose Cuervo, Tanqueray, and Crown Royal. Other widely recognized brands include Dom Perignon and Moet & Chandon.
  3. Effective distribution networks. Diageo has one of the strongest distribution networks in the industry. It is the only spirits company to use dedicated wholesalers in the U.S.
  4. Exposure to emerging markets. Diageo operates in 180 countries, but it has slated emerging markets as a driver for growth. The company spends $0.72 of every marketing dollar in emerging markets. Diageo is the No. 1 international spirits company in Africa, Latin America, and Asia. These markets comprise one-third of Diageo's net sales -- up from 22% in 2005 -- and they are expected to contribute up to 50% of Diageo's net sales by 2015.
  5. Product innovations. New flavor offerings for Diageo's Ciroc brand more than doubled its net sales of vodka for that brand last year and grew its entire portfolio 7%. Diageo actively pursues innovations involving ready-to-serve cocktails. Smirnoff ready-to-drink box mixes were launched in Australia, and pre-mix cans were recently launched in various global markets.

Raising the bar
As seen in the table below, Diageo boasts a market cap six to 16 times that of its major competitors, has a leg up on global presence, and posts a solid return on equity. Diageo has paid a hefty dividend since 1988 and increased it for 13 consecutive years.

Company

Market Cap

% Revenues from Outside US

ROE

Dividend Yield

Diageo$66 billion62%30.3%2.7%
Brown-Forman (NYS: BF.A) $11 billion55%29.4%1.8%
Beam (NYS: BEAM) $9 billion45%2.7%1.4%
Constellation Brands (NYS: STZ) $4 billion37%23.2%0

Sources: Yahoo! Finance; companies' 2011 annual reports.


Competition
Last year, Diageo posted a 1% drop in net sales for its ready-to-drink category, but this segment continues to grow in emerging markets. Competition comes from Beam with its successful Skinnygirl product, a low-calorie brand of cocktails. Beam is now a pure-play spirits company. Eleven of its top 14 brands have been acquired in the past six years. Beam's balance sheet continues to hiccup from its acquisition binge.

Constellation Brands is primarily a wine company with smaller spirits and beer portfolios. The company sold a good chunk of its spirits business in 2009 to focus on premium, high-growth, and high-margin brands in its portfolio.

Brown-Forman's own rival efforts are focused in spirits. Its single-serve Jack Daniel's product was the best-selling ready-to-drink brand in Germany last year. I see Brown-Forman as the biggest threat to Diageo because of its strong balance sheet, its focus on the higher-margin spirits business, and its emerging market presence.

Opportunities
Beverage companies also compete by securing partnerships. Starbucks (NYS: SBUX) began serving alcohol in several of its Seattle cafes in 2010. In true Starbucks fashion, local winery Chateau Ste. Michelle had its wines featured at Starbucks' East Olive Way location.

Starbucks plans to begin selling beer and wine in several cafes in Chicago, Atlanta, and California by the end of the year, and this could bode well for Diageo if the coffee juggernaut anoints it as the chosen one. However, a pure-play wine company with an extensive portfolio of wines from varying locales, like Constellation Brands, could reign supreme. Granted, Starbucks' beer and wine offerings are still in their absolute infancy, but if it is successful, Starbucks has the sheet size to make for a compelling partnership.

Recipe for Success
A well-diversified, agile company with ample emerging-market exposure and brand dominance is best suited to cater to changing consumer preference. For the moment, that company is Diageo, but that could change in this dynamically spirited industry.

One of Diageo's most promising characteristics is exposure to emerging markets. While it commands serious brand strength abroad, it didn't quite make our list of "3 American Companies Set to Dominate the World." You can see which titans did by clicking here now. Enjoy, and Fool on!

At the time this article was published Fool contributorNicole Seghettienjoys a full-bodied Barolo. She does not own any of the stocks mentioned in this article. The Motley Fool owns shares of Starbucks.Motley Fool newsletter serviceshave recommended buying shares of Diageo, Beam, and Starbucks and have recommended writing covered calls on Starbucks. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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