Liquidity and capital resources

Cash flow

A summary of the cash flow and reconciliation to movement in net borrowings for the three years ended 30 June 2009 is as follows:

The primary source of the group’s liquidity over the last three financial years has been cash generated from operations. These funds have generally been used to pay interest, dividends and taxes, and to fund share repurchases, acquisitions and capital expenditure.

Free cash flow decreased by £48 million to £1,204 million in the year ended 30 June 2009. Cash generated from operations increased from £2,305 million to £2,626 million in the year ended 30 June 2009. This £321 million increase primarily arose from an increase of £217 million in operating profit, an increase of £30 million in the dividend received from Moët Hennessy and a decrease of £18 million in property profits (included in operating profit).

Tax payments were higher in the year ended 30 June 2009 than in the comparative year primarily as a result of settlements agreed with tax authorities in the year ended 30 June 2009.

In the year ended 30 June 2009, Diageo invested £102 million in business acquisitions (2008 – £575 million) and purchased 38 million shares as part of the share buyback programme (2008 – 97 million shares) at a cost including fees of £354 million (2008 – £1,008 million). Net payments to acquire shares for employee share schemes totalled £38 million (2008 – £78 million). Equity dividends of £870 million were paid during the year (2008 – £857 million).

Capital structure and credit rating

The group’s management is committed to enhancing shareholder value, both by investing in the businesses and brands so as to improve the return on investment and by managing capital structure. Diageo manages its capital structure to achieve capital efficiency, maximise flexibility and give the appropriate level of access to debt markets at attractive cost levels. This is achieved by targeting a range of ratios which are currently broadly consistent with a single A credit rating.

Capital repayments

During the year ended 30 June 2009, the company purchased 38 million ordinary shares for cancellation (2008 – 97 million for cancellation; 2007 – 120 million for cancellation and 21 million to be held as treasury shares) as part of its share buyback programme, for a total consideration of £354 million including expenses (2008 – £1,008 million; 2007 – £1,405 million). In addition, the company purchased 6 million ordinary shares to be held as treasury shares for hedging share scheme grants provided to employees during the year (2008 – 11 million; 2007 – 9 million) for a total consideration of £63 million (2008 – £124 million; 2007 – £82 million).

The group regularly assesses its debt and equity capital levels against its stated policy for capital structure. Share repurchases for cancellation were suspended during the year ended 30 June 2009 and remain suspended as at the date of this report.

The total number of shares purchased for settlement in each calendar month and the average price paid excluding expenses for the year ended 30 June 2009 were as follows:

• Notes
• (a) All shares were purchased as part of publicly announced programmes.
• (b) Authorisation was given by shareholders on 16 October 2007 to purchase a maximum of 263,122,000 shares. Under the authority granted, the minimum price which may be paid is 28101⁄108 pence and the maximum price is the higher of (a) 105% of the average of the middle market quotations for an ordinary share for the five preceding business days and (b) the higher of the price of the last independent trade and the highest current independent bid on the London Stock Exchange at the time the purchase is carried out. The expiration date for the programme was 15 October 2008.
• (c) Authorisation was given by shareholders on 15 October 2008 to purchase a maximum of 252,025,000 shares. Under the authority granted, the minimum price which may be paid is 28101⁄108 pence and the maximum price is the higher of (a) 105% of the average of the middle market quotations for an ordinary share for the five preceding business days and (b) the higher of the price of the last independent trade and the highest current independent bid on the London Stock Exchange at the time the purchase is carried out. The expiration date for the programme is 14 October 2009.

Borrowings

The group policy with regard to the expected maturity profile of borrowings of group financing companies is to limit the amount of such borrowings maturing within 12 months to 50% of gross borrowings less money market demand deposits, and the level of commercial paper to 30% of gross borrowings less money market demand deposits. In addition, it is group policy to maintain backstop facility terms from relationship banks to support commercial paper obligations.

The group’s net borrowings and gross borrowings in the tables below are measured at amortised cost with the exception of borrowings designated in fair value relationships, interest rate hedging instruments and foreign currency swaps and forwards. For borrowings designated in fair value relationships, Diageo recognises a fair value adjustment to the risk being hedged in the balance sheet, whereas interest rate hedging instruments and foreign currency swaps and forwards are measured at fair value. Net borrowings, reported on this basis, comprise the following:

Based on average monthly net borrowings and interest charge, the effective interest rate for the year ended 30 June 2009 was 6.2% (2008 – 5.9% 2007 – 5.5%). For this calculation, the interest charge excludes finance charges unrelated to net borrowings, the forward element on derivative financial instruments and fair value adjustments to borrowings.

Designated net borrowings in net investment hedge relationships amounted to £5,266 million as at 30 June 2009 (2008 – £5,396 million2007 – £4,624 million).

The group’s gross borrowings were denominated in the following currencies:

Cash and cash equivalents were denominated in the following currencies:

During the year ended 30 June 2009, the group borrowed $1,500 million (£909 million) in the form of a global bond that matures in January 2014 with a coupon of 7.375% and €1,000 million (£855 million) in the form of a global bond that matures in December 2014 with a coupon of 6.625%. A €500 million (£427 million) medium term note, a $400 million (£242 million) medium term note and a $250 million (£152 million) medium term note were repaid. During the year ended 30 June 2008, the group borrowed $750 million (£367 million) in the form of a global bond that matures in 2013, €1,150 million (£917 million) in the form of a euro bond that matures in 2013 and $1,250 million (£611 million) in the form of a global bond that matures in 2017. During the year ended 30 June 2007, the group borrowed $600 million (£298 million) in the form of a global bond that matures in 2012, $600 million (£298 million) in the form of a global bond that matures in 2016, $600 million (£298 million) in the form of a global bond that matures in 2036 and €750 million (£507 million) in the form of a floating rate euro bond that matures in 2012. The proceeds of all issuances have been used in the ongoing cash management and funding activities of the group.

When derivative transactions are undertaken with bank counterparties, Diageo may, where appropriate, enter into certain agreements with such bank counterparties whereby the parties agree to post cash collateral for the benefit of the other if the net valuations of the derivatives are above a pre-determined threshold. At 30 June 2009, the collateral received under these agreements amounted to $84 million (£51 million) (2008 – $nil, £nil).

At 30 June 2009, the group had available undrawn US dollar denominated committed bank facilities of $3,480 million (£2,109 million) (2008 – $3,230 million (£1,623 million)2007 – $3,230 million (£1,607 million)). Of the facilities, $400 million (£242 million) expire in May 2010, $1,080 million (£655 million) expire in May 2011, $1,350 million (£818 million) expire in May 2012 and $650 million (£394 million) expire in May 2013. Commitment fees are paid on the undrawn portion of these facilities. Borrowings under these facilities will be at prevailing LIBOR rates (dependent on the period of drawdown) plus an agreed margin. These facilities can be used for general corporate purposes and, together with cash and cash equivalents, support the group’s commercial paper programmes. The committed bank facilities are subject to a single financial covenant, being a minimum interest cover ratio of two times (defined as the ratio of operating profit before exceptional items aggregated with share of associates’ profits to net interest). They are also subject to pari passu ranking and negative pledge covenants.

Any non-compliance with covenants underlying Diageo’s financing arrangements could, if not waived, constitute an event of default with respect to any such arrangements, and any non-compliance with covenants may, in particular circumstances, lead to an acceleration of maturity on certain notes and the inability to access committed facilities. Diageo was in full compliance with its financial, pari passu ranking and negative pledge covenants throughout each of the periods presented.

Capital commitments not provided for at 30 June 2009 were estimated at £202 million (2008 – £130 million 2007 – £86 million). Diageo management believes that it has sufficient funding for its working capital requirements.