There was some cheer for long-suffering Diageo (LSE: DGE) shareholders this week. A trading update from the Guinness brewer yesterday (6 May) saw Diageo shares rally on some shots of good news.
So could it be that the long-awaited turnaround in the alcohol company’s shares has begun?
Facing down the big challenges
Two problems have dogged Diageo over recent years, which may or may not be related. One is the overall decline in alcohol consumption, notably among younger generations.
The second is a drop in demand for premium-priced white spirits. That may be a normal part of the economic cycle as consumers tighten their belts, or it could be a permanent shift as wider patterns of alcohol use change.
What then, has this week’s news from Diageo helped investors learn when it comes to these important points?
The company maintained its full-year guidance of a 2%-3% fall in organic net sales. White spirits sales in Greater China fell by an unspecified double-digit percentage. Even more alarmingly, US spirits organic net sales fell by 15% year-on-year.
In the equivalent period last year, some US customers ordered more than usual to try and squeeze shipments through customs before tariff changes kicked in. Still, the sharp decline in Diageo’s biggest market is alarming.
More positively, spirits organic net sales grew strongly in Europe. This was pinned on increased sales of Scotch whisky, led by the Johnnie Walker brand.
A mixed bag then, but with enough data suggesting that white spirits sales continue to be an area of significant concern.
Diageo’s next moves are crucial
Fixing the demand side of the business is crucial to its long-term health, in my view.
What comes next matters. Can Diageo reignite consumer demand for its more premium white spirits? Or will it focus on cheaper spirits and ales, potentially helping sales volumes but hurting profit margins? That choice will be crucial.
An efficiency programme is on course to deliver around $300m of cost savings by the end of the current financial year. Thats welcome news for the company’s profitability, but you cannot cut your way to growth.
My take as a shareholder
Something else that concerns me is this year’s free cash flow forecast. At $3bn, it is higher than last year, which is positive. But my worry was that that number excludes around $100m of costs as the company builds stock levels ahead of a planned software change.
I see working capital cash flows, even one-offs, as cash flows. If Diageo is willing to exclude this cash movement, what other details might I need to pore over in the accounts to inform myself properly as a shareholder about the company’s financial performance?
Falling sales are a problem and, as mentioned, I have concerns about future profit margins too. A swingeing dividend cut this year badly hurt my confidence in management’s priorities.
With its strong brands throwing off several billion pounds a year in free cash flow, I remain upbeat about the business foundations. But there is a lot of work still to be done. Combined with wider market trends, that means I think Diageo shares could potentially continue to tread water for a while.
I will hang on to mine for now — but will not be buying any more.
