CHARLES NORTON
CO-PORTFOLIO MANAGER
THE VICE FUND (VICEX)

COMPANY: Diageo
TICKER: DEO (NYSE)
PRICE: $65.77 (as of 4 p.m. Friday)
52-WEEK RANGE: $54.75-$66.04
MARKET CAPITALIZATION: $46.92 billion

Charles Norton is the co-portfolio manager of the Vice Fund (VICEX), a mutual fund that invests mainly in alcohol, defense, gaming, and tobacco companies. Diageo manufactures and distributes spirits, wines, and beers worldwide. Mr. Norton spoke to David Dalley about why an ongoing shift in consumer preferences makes Diageo a strong investment.

Why do you like Diageo?

The major theme that we’re seeing right now within the alcohol industry is that consumers are increasingly choosing spirits and wine at the expense of domestic beer. Diageo is the world’s leading premium spirits company. Its brands include Smirnoff, Johnny Walker, and J&B whiskey, as well as Jose Cuervo and Seagram’s. That alone is one reason we like them. They’re well-positioned to take advantage of that shift in consumer preference.

They’ve also been buying back stock hand over fist, and they have a nice 3.25% dividend yield. The stock currently trades at a discount to the sector. They’re also a key supplier of liquor for Wal-Mart, and Wal-Mart has said that it plans to quintuple its alcohol sales over the next five years.

What are the fundamentals like?

Sales and earnings have been a bit spotty, but this year I think they could be up 25% from last year. Last year they earned $3.06. I think that they could earn $3.80 this year. They’re trading at about a 20 multiple, which I think is very reasonable.

We also like to look at the technical aspects and at chart patterns. Diageo has been trading at around $60 for about a year, and it’s only now breaking out of that range, which makes now a good time to be getting in.

What about the competition?

In this category there’s obviously competition, but a lot of this industry is about brand awareness, and I think Diageo is very well-positioned with the stable of brands that they have to compete successfully.

Apart from the shift in consumer preferences, what else drives growth?

They’ve acquired a couple brands, such as Bushmills whiskey from Pernod Ricard, which is the world’s no. 3 liquor maker. That was about a $365 million deal. They’re not really known for their acquisitions, though. They already have a very good stable of highquality brands. Their growth has been mainly organic.

What are the risks?

I would say more competition, or a significant change in consumer preferences. But I don’t think that will hap pen, especially with the aging baby boomer population. Older people tend to prefer wine and spirits, so if anything I think that the trend will accelerate.