According to the FT “One theory in circulation was that Diageo might put together a friendly deal with Brown-Forman, the maker of Jack Daniels and Southern Comfort. The US group’s controlling shareholders [the Brown family] have been rumoured to be open to a sale or disposal, with Bacardi also linked with an interest. However, Diageo and Brown-Forman are not thought to be in talks.”

We see this as unlikely for two reasons. First, Brown-Forman (BF) has a longstanding commitment to independence, supported by the dominant influence of the Brown family. Second, BF has a close relationship with Bacardi, which involves joint distribution in many markets. Were BF to seek a deal we see Bacardi as the more obvious partner, for this reason and because of the more similar size of the two companies. A deal between BF and Bacardi could be something akin to a merger, whereas a deal with Diageo would be a straight takeover of BF.

The decision can therefore come down to how categories are defined. For example, we would argue that Diageo has no significant presence in the premium American whisky category, where BF’s Jack Daniels is the leading brand in the US. However, if this category was defined more widely as all American whiskey regardless of price then Diageo’s ownership of the Seagram’s 7 Crown brand could be an issue (these are the no.1 and no.3 American whiskies in the US market). Similarly, if the whisk(e)y category was defined more widely regardless of national origin, then Diageo ownership of the Crown Royal Canadian Whisky brand could be problematic. Jack Daniels and Crown Royal are the two leading North American whiskies in the US market and sell at a similar price point (Jack Daniels $20.30, Crown-Royal $22.90).

Although it is too early to start wondering about the impact on Diageo’s EPS and ROIC given that we have no idea on price (even if the deal went ahead) we would make the following general point. Deals in the spirits industry can go ahead at substantial premiums whilst still creating value for the acquirer given the synergies available. In this case Diageo could acquire BF’s brands and incur very limited additional cost in distributing them, thus making a substantial saving. Given this point, and the strategic merits for Diageo of acquiring another category-leading brand, we would be supportive of a deal as long as the price was not stratospheric.

The FT also reported that “Another suggestion [yesterday] was that Diageo might look at buying a brewer, which would be less likely to trigger competition concerns.” This is a longstanding theory put forward by some of our competitors. We give it no credence as it would almost certainly dilute Diageo’s returns, growth and focus on the premium spirits category, and hence be inconsistent with the company’s strategy.

‘chateau’, ‘classic’, ‘clos’, ‘cream’, ‘crusted/crusting’, ‘fine’, ‘late bottled vintage’, ‘noble’, ‘ruby’, ‘superior’, ‘sur lie’, ‘tawny’, ‘vintage’ or ‘vintage character.’

Bureaucracy at its finest. I certainly understand protecting rights to regions but not simple words with more than a location’s name at heart.

Industrial output in the UK has dropped 13% from its peak early last year and, after the 1% decline in February, is set to be down roughly 5% in Q1 from Q4 – alone reducing the
level of GDP by a little over 1%. These figures are consistent with recent evidence from
the host of business surveys covering the sector (e.g. CBI, BCC, PMI), which all report
still shrinking order books and elevated inventory levels. The largest drop in car sales since the mid-70s recession has been particularly problematic for UK industrial firms, not least the large network of domestic parts suppliers.

The case in favour of a return to growth during the second half of the year remains in
place. Large-scale asset purchases by the central bank appear to be having a meaningful
impact on monetary conditions and corporate liquidity. Car sales, the collapse of which has been a major component of the manufacturing malaise, appear to have flattened off at a monthly rate of 140,000 (LSR seasonal adjustment). Meanwhile, the inventory overhang appears limited in the UK, with massive liquidation at the end of last year leaving stock levels in line with their long-term trend (i.e. a better position than normally would be the case at this point in the cycle). However, in Q1 the scale of the output decline is set to be larger than we had forecast in our January Quarterly Economic Forecast, most likely ending up in the 1-1½% range rather than the ½-1% range previously assumed (markedly worse outturns for manufacturing activity outweighing better than expected news from the service sector).

The pace of economic deterioration has slowed
Our economists believe that we are past the low point in the economic cycle, although we are far from
expansionary territory. This is one of the signposts we were waiting for before getting more positive on the market and cyclicals. But it does not mean it is the start of a new bull market – it is dangerous to view the current cycle as ‘normal’ given the overlay of the ongoing credit crunch and balance sheet deleveraging. Our strategy is to trade the cycles as they emerge, but be nimble as we may need to make more frequent sector changes than typically following a trough.

Cyclical stocks such as FTA TV highly correlate with sales (advertising revenues) and earnings revisions. We think that we are far from seeing conditions leading to positive earnings revisions for the advertising driven stocks. Given the continued negative earnings revisions of the TV stocks in our coverage, further deterioration in macro economic forecasts, the fact that, in a recession, the advertising market typically lags any economic upturn by one to two years, and our analysis of FTA share price performance in the early 90s recession, we think that it is still to early to buy into TV stocks. The experience of earlier recessions in which advertising recovery lags the recovery of the economy at large suggests that – even when the economy finally starts to show better performance – there is a risk of a
short rally followed by further disappointment as the expected advertising revenues and earnings do not come through concomitantly.

We still prefer defensive/late cyclical stocks with lower exposure to the economy. For investors looking for some exposure to the economic cycle, we still recommend Professional Publishing stocks, since they show less downside if the economy continues to deteriorate and are not affected by negative structural issues. In addition the Professional Publishers do have some exposure to more cyclical business (Reed Elsevier: Exhibitions and RBI, Pearson: FT newspaper, Wolters Kluwer: transactional segment of Corporate and Financial Services division) for which estimates of a severe downturn are already for the most part factored into estimates. Should the economy recover earlier than anticipated, these businesses could still surprise on the upside, with the result that the stocks should not be left as far behind as some investors envisage.

_ Within the TV segment, we rate BSkyB Outperform (target price £5.50). We continue to believe that Pay TV will remain resilient even in the current economic environment and that the company will in fact emerge as a beneficiary due to the weakening of its FTA competitors in the UK TV market.

With diamond prices tumbling by at least 30 per cent over the past year, De Beers has cut production at its mines by 40 per cent year-on-year and mothballed its flagship mines in Botswana.

The Committee noted that since its previous meeting a total of just over £26 billion of asset purchases had been made and that it would take a further two months to complete that programme.

The minutes of the meeting will be published at 9.30am on Wednesday 22 April.