Peter Clowes and Andrew Corwin

What is Diageo (DEO)? Diageo is the largest premium spirits company in the world with control of 8 of the top 20 liquor brands. Diageo has a market cap of $27.05 Billion. Diageo has the largest global presence and established distribution system among premium liquor companies. Diageo’s high end, branded products yields impressive profit margins. Best of all, Diageo is undervalued: Price per share: $41.14 (as of 3/9/09) Fair Value Estimate: $78.28

Diageo’s Top Global Brands

A Socially Responsible “Sin” Stock Social Sustainability 110 responsible drinking programs in 45 countries 1.1% of Operating Profit donated annually to direct investment in local communities Environmental Sustainability Goal: Reduce company wide emissions by 5% Goal: Reduce non-ingredient water used by 50% 95% of solid waste was reused/recycled in past year, goal of 100% by 2015

TTM Performance:

Holding Period Performance:

Industry Overview In the premium spirits sub-industry, Diageo is the current market leader. This sub-industry is highly competitive due to the lucrative margins it generates. There can only be a limited number of “premium” brands. Distribution and Brand Equity are crucial.

4. Threat of Substitutes: Medium Porter’s Five Forces: 1. Buyer Power: Low 2. Supplier Power: Low 3. Threat of Entry: Low 4. Threat of Substitutes: Medium 5. Rivalry: High

Ratio Analysis Diageo (DEO) Brown-Foreman (BF.A) Constellation Brands (STZ) CEDC (CEDC) Mkt. Cap 34.97B 7.69B 3.43B 0.64B P/E Ratio 11.75 17.22 (4.71) 5.73 EPS $4.73 $2.96 ($3.33) $2.41 Dividend Yield 4.83% 2.13% 0% Dividend Payout Ratio 57.32% 81.06% ROE .36 .26 (.26) 0.14 NI/Sales .18 .17 (.19) 0.09

Valuation Overview: Growth Forecast Profitability Free Cash Flows Access to FCF Valuation

Weighted Contribution Growth Forecast Region Projected GDP Growth DEO Growth % of Total Sales Weighted Contribution N. America 2.3% 3.1% 28.1% 0.9% Europe 3.2% 38.3% 1.2% Asia / Pacific 6.5% 6.0% 11.1% 0.7% International 4.7% 7.0% 22.5% 1.6% Total DEO Growth: 4.34% *Source: IMF (www.imf.org)

Profitability: Key Drivers Premium Products: High Brand Loyalty High Margins Unique Distribution Network: Efficient Distribution Creates Competitive Advantage Exclusive Distribution Rights Among Vendors

Profitability: Margins Combining DEO’s growth with its key drivers results in sustainable and defensible profit as evidenced by these margins: 3-yr Trailing Average Gross Margin: 63% 3-yr Trailing Average Operating Margin: 28% 3-yr Trailing Average Profit Margin: 21%

FCF Generation 2006 2007 2008 2009 2010 2011 Net Income $3,528 $2,709 $2,976 $3,613 $3,479 $3,734 Free Cash Flows $1,226 $1,514 $1,179 $2,042 $2,745 $2,702 FCF/NI 35% 56% 40% 57% 79% 72% Chart: 3back 3 forward w/ NI & FCF,

Access to FCF 2006 2007 2008 2009 2010 2011 Net Income $3,528 $2,709 $2,976 $3,613 $3,479 $3,734 Free Cash Flows $1,226 $1,514 $1,179 $2,042 $2,745 $2,702 Dividends $1,598 $1,721 $1,706 $1,780 $1,860 $1,946 Divs/FCF 130% 114% 145% 87% 68% 72% Stock Buyback $3,329 $4,388 $4,737 - Price Per Share $60.85 $77.60 $71.03 $80.74 $90.56 $101.08 *Prices in Millions USD (Except Per Share Data)

Valuation Target Price: $78.31 Price as of 3/31/09: $44.75 Model Outputs: Model Implied Price 6/30/08: $71.04 Actual Price for 6/30/08: $71.03 Per Share Value of Future Dividends: $76.19 (Discounted by Ke at 8.71%)

Methodology Growth Forecast: 4.34% fading to 5% after five years. WACC: 7.69% Risk Free: 3.25% (adjusted by 50 bps) Cost of Debt: 7.95% Cost of Equity: 8.71% Beta: .77

Risk Analysis Currency exposure due to recent depreciation of the British Pound versus the U.S. Dollar. When the U.S. enters an inflationary period, due to the large amounts of cash being injected into the economy, Diageo will be protected. Economic slowdown may result in less high end purchases. Consumers may trade down, but historically, premium spirits are resilient. Scotch and whiskey have seen an increase during this economic cycle.

Sensitivity Analysis: COGS Sales   +10% +5% Constant -5% -10% -20% $95.93 $86.74 $78.34 $70.67 $63.68 $51.58 $92.62 $83.69 $75.52 $68.09 $61.32 $49.62 $89.31 $80.63 $72.71 $65.51 $58.96 $47.67 +15% $85.99 $77.57 $69.90 $62.92 $56.60 $45.71 *The percent changes in this analysis are deviations from near term starting rates. Long term values are held constant. Prices are per share values.

Diageo’s Value Proposition: Sustained Growth and Aggressive Growth Opportunities Defensible Profit Margins Stable Earnings and High FCFs Actual Return of FCFs to Shareholders Highly Undervalued