Projections and Valuation: Free Cash Flow to Equity (FCFE). This Beta: model is appropriate because

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1 Fundamental Value: $4.48 Market Price: $ Week Range: $2.40 to $6.00 Recommendation: Hold 2 Symbol: DG Shares Outstanding: 2,809,171,264 units Market Value of Shares Outstanding: $14,158,223, Financial Year End: June 30 Executive Summary: DG manufactures a range of alcoholic brands ranging from beers, stouts to other beverages. The company, which is majority owned by Diageo PLC also markets and distributes other premium brands from the parent. The flagship product, Red Stripe beer, was first brewed in Jamaica in 1928 and is available in over 20 markets worldwide. Diageo is listed on both the London and New York Stock Exchanges. The company has suffered sales declines in the local market as a result of the contraction in consumer demand and higher prices consequent on tax increases. Turnover declined 0.5% in 2011 with an outturn that was $60M lower than in However, export sales growth of 3% year on year resulted in a net sales value in 2011 that was down just 1% vs the prior year. Company Overview: In addition to producing Jamaica s beer, Red Stripe, Desnoes and Geddes is also a distributor of leading spirits including, Bailey s Irish Cream, Johnnie Walker, Guinness and Smirnoff. In December 2010, the Government of Jamaica implemented a tax increase on alcoholic beverages based on alcohol volume, with different rates corresponding to three categories of alcoholic drinks. This new framework reduced the anomaly that existed between the beer and stouts category and other alcoholic beverages. In response to declining sales in the local market and increased competition from lower priced and new categories of drinks impacting the performance of the company, the Board of Desnoes & Geddes have decided to embark on an aggressive export strategy for the North American market. The company advised that, effective April, the company will move to a licensed production model for the North American market, effectively moving production of the drinks for that market within North America. The Board believes that the brand will get greater support in the North American market, thereby increasing volumes and improving margins. We believe this is critical to the future growth of the Red Stripe brand, as it allows for savings gained from economies of scale in production and lower distribution costs to be invested in additional support to increase brand visibility in the ultra-competitive US market. Although we like the firm's focus on premium brands and investments in international growth, we believe that weakness in the North American and local markets could also have a negative impact on earnings. Additionally, little has been said about the number of redundancies in the company within the last 4 years and its potentially traumatic effect on the organization and the remaining staff members. The number of employees at Red Stripe has so far declined from 767 persons in 2008 to 624 persons at the year ended The ouncement of the move overseas should also impact employee morale significantly as inevitably there will be further job loss. Red Stripe will leave itself open to sabotage and other forms of people risks if the separation is not handled well. Financial Performance Profit and Loss Summary- 12 months ended October 31 June June Change (%) Net Sales (J$M) 11,156 11,105 0 Trading Profit ($JM) 1,423 1, Profit before tax (J$M) 1,447 1, Profit after Tax (J$M) EPS ($) Outlook: D&G possesses a broad portfolio of strong beverage brands which can create a competitive advantage if the brands are leveraged to their full potential. The premium brands can gain premier shelf space and Red Stripe can successfully negotiate with retailers on pricing. We believe that D&G/ Diageo is effectively able to leverage its strong brands such as Johnnie Walker and Smirnoff vodka to drive retail traffic, which makes it an invaluable partner to retailers across the globe and ensures that its competitive edge remains intact. However, the company faces many challenges, not the least of which includes market forces. Projections and Valuation: Free Cash Flow to Equity (FCFE). This Beta: model is appropriate because positive free cash flows can be Expected Market Return: 11.07% forecast in a reasonable time period, the cash flows align with Country Risk Premium: 8.76% the company s profitability and Equity Risk Premium: 5.28% the company is in a mature industry. According to the Risk Free Rate: 2.31% Gordon Growth model, DG Source: Bloomberg should grow at an initial rate of 14.5% over the next 3 years and then at a sustainable rate of 5.5%. We believe the initial growth rate can be realized if DG s move to manufacturing in the US is successful. The cost of equity is calculated using the Capital Asset Pricing Model (CAPM) model. Cost of Equity of 5.5% is adjusted to include the country risk premium and the equity risk premium. Based on this model, the stock has a fair market value of $ As at December 1, Security is expected to perform with market or at the same pace as comparable companies. Neither purchase nor sell these securities at current prices. 3 As at December 1,

2 Dividend Timetable 2011/ 2009/ /2009 Payment date Dec Jun Dec Jun Dec Dividend Per Share ($) D&G s dividend payment history indicates that the company seems to pay dividends twice per year in June and December at a fairly consistent dividend per share. However, the company is not consistent with its payment schedule, which may be a deterrent to investors seeking a stable income source. Management and Corporate Governance On June 30, 2011, Alan Barnes, who led the Group as Managing director for two years, demitted office, clearing the way for Brazilian national, Renato Gonzalez, to assume the role. Gonzalez, who commenced leadership on July 1, 2011, is an experienced member of the leadership team of Diageo. We applaud the separation of the chairman and CEO roles on the Board of Directors. However D&G s 12 member Board comprises only 5 independent members. This is a potential red flag in corporate governance. Shareholder Number of Units Held Percentage Held Udiam Holdings AB 1,625,549,827 58% Heinekan Finance NW 303,454,633 11% Heineken International BV 130,578,508 5% NCB Proprietary A/C 100,773,750 4% Bardi Limited (in Bankruptcy) 84,255,986 3% LOJ PIF Equity Fund 45,441,367 2% National Insurance Fund 31,709,129 1% Jette Limited 26,254,292 1% Vicsol Services Limited 21,657,946 1% Ivn Nom Ltd. A/C Las Henriques et al S/F 1,625,549,827 1% SWOT Analysis Strengths Strong brand recognition, premium brand image Market leader in beer and stouts category locally Wide distribution network and support base Strong parent Diageo PLC also world's largest spirits maker. Strong position in North America. Weaknesses High input costs (taxes, energy, etc) can suppress operating results Some products are aged and have long inventory holding periodssusceptible to costs associated with inventory and inflation Opportunities Beer brands (Red Stripe, Guinness) can serve as gateway to other alcoholic beverages North American market is highly competitive but can be very profitable with appropriate support base for products Diageo's global scale should enable company to reap cost and revenue synergies Threats Business subject to tax collection and regulation changes without notice, which can either increase costs or limit business activities, or both Strong competition from roots wines (cultural affinity to beverage) After effects of recession affecting demand for high end beverages Customer's tastes and preferences change over time. 2

3 Ratio Analysis Risk: Key risk metrics reveal that the security is a relatively safe investment. D&G is not very leveraged although there could be a more adequate provision of cash to cover liabilities. The proportion of debt to equity has declined after The company is exposed to systematic risks associated with the Jamaican economy including soft consumer spending as a result of the weak economy. The company is also exposed to regulatory risks because alcohol products are highly regulated and taxed, the government may take actions that either increase DG s costs or limit its business activities. However, there is unlikely to be any addition of taxes in the foreseeable future as the government and the company is in discussions to make the current taxes more equitable. Additionally, as a result of operating across different countries, foreign exchange rate fluctuations can cause large swings in DG s financial results. The company has however mitigated this risk by holding a portion of its income in USD. The company s inventory is susceptible to environmental risks. The inventory can be lost due to contamination, fire, or other natural disasters. Additionally people risks can include sabotage, which can also compromise inventory. If these risks occur, DG may not be able to satisfy consumer demand, and insurance may not fully cover the replacement value of the lost inventory. However we think this is unlikely unless in extreme circumstances Liquidity risks pertain to the group s ability to meet its financial obligations in a timely mer. D&G s inventory turnover rate is low at between 4.11x to 6.61x. While this may appear to be a sign of liquidity pressure, Red Stripe has a portion of its inventory (scotch, tequila and rum) that are maturing products and which necessarily sit and age for a longer period of time. Therefore, given the nature of the business, inventory turnover is, in our view, satisfactory. However, its current ratio, which has been relatively flat to declining since 2007 increased slightly in 2011 and continued this trend in the first quarter of. We expect this trend to continue, although we would feel more comfortable with a more substantial amount of working capital to fund market expansion. D&G s operating performance has fluctuated over the five year period as management struggled to maintain satisfactory returns for stockholders. ROE has declined however to 6.46% in the first quarter of (on an ualized basis). Value: The Price to earnings ratio has fluctuated over the five year period but has shown a marked increase for the period. Investors will be paying more relative to the level of earnings being generated by the company. EPS has declined, indicating that the value generated from a given number of shares has decreased consistently over the 5-year period. We expect that with the plan to seek out new markets and as growth plans are realized, EPS should improve over the medium term. The Book Value per share is also less than the current market price which should change with an initial growth rate of 14.5%. Indicated dividend yield is generally above market price. DG s financial results have been hampered by elevated unemployment and economic uncertainty in Jamaica Debt/Equity (x) CF/Total liabilities Financial Leverage (x) Inventory Turnover (x) Risk Liquidity Current ratio (x)

4 $ VMWM Research Department, January 9, Value EPS P/E (x) BVPS (x) DPS$ Technical Analysis Moving Average Convergence Divergence (MACD) Source: Bloomberg MACD calculates two price averages to locate turning points in a trend. The difference is calculated as the MACD1. A change in the trend occurs when the MACD1 period indicator (white line) crosses the signal indicator (red line). If MACD1 period crosses the signal indicator from below, it indicates a positive change in trend (buy signal). If the MACD1 period indicator crosses from above it indicates a negative change in the trend (sell signal). As at November 22, 2011, the MACD1 period indicator is signaling a buy trend, crossing the red line from below. 4

5 Relative Strength Index (RSI) - BUY The Relative Strength Index (RSI) measures the velocity of directional price movements. Rapid upward price movements indicate overbought conditions and a sell signal, while rapid downward price movements indicate oversold conditions, a buy signal. Similarly, RSI levels in excess of 70% are thought to indicate overbought conditions, while RSI levels below 30% are thought to indicate oversold conditions. Traders prefer RSI levels of 75% and 25% as their basis for overbought and oversold conditions, respectively. The RSI of 14 is a buy signal. JSE Moving Average Chart The JSE moving average chart shows the trend in price movements of the DG stock over 1 year beginning November The Chart shows the price (red line) breaking through the moving average line (blue) from below in October. The moving average line itself moves higher with the price, suggesting a general appreciation in price. This is a buy signal. As at December, 2011, the stock is up 9.57% month to date and 40.39% year to date on the JSE. Recommendation Notwithstanding the challenges, we believe Red Stripe has the potential to perform well and the current price has not topped the 52 week high. We recommend a hold with a potential to buy below $6.25. Prepared by VMWM Research Department, December 2, 2011 Disclaimer: This Research Paper is for information purposes only. The information stated herein may reflect the opinion and views of VM Wealth Management in relation to market conditions and does not constitute any representation or warranties in relation to investment returns and the credibility of the sources of information relied upon in the preparation of this report, without further research and verification. Before making any investment decision, please consult a VM Wealth Management Advisor. 5