Diageo (LSE:DGE) shareholders have had a rough ride over the last few years. The stock’s down around 62.5% from its highs, and the dividend just got cut for the first time in decades.
So why am I even mentioning a comeback?
What’s been happening?
New CEO Sir Dave Lewis — who built a decent reputation turning Tesco around — took charge in January. Since then, it’s been one restructuring move after another.
Diageo agreed to sell its East African Breweries stake to Asahi for roughly $2.3bn, which helps strengthen its balance sheet. A $300m-plus cost-savings programme is also underway.
The most important sign, however, is that revenues are growing. Not by much — up 0.3% with volumes up 0.4% — but progress is progress.
The stock responded, rallying from a March low near 1,363p to over 1,600p, before settling back around 1,500p. Nobody’s declaring victory, but it feels like something’s shifted.
Fixing the balance sheet
One of Diageo’s big issues is its debt. Companies can generally get through downturns in popularity with patience, but that’s harder when they have interest payments to make.
Net debt in the interim update was $21.7bn. That’s still pretty high, but cutting the dividend should help free up cash to bring this down.
It’s a move I saw coming – Drastic Dave did the same thing at Tesco – and I’m in favour of it. Over the long term, I expect it to help bring stability.
Combined with the divestiture proceeds, I think the firm is finally getting a grip of its balance sheet. It’s not exciting, but it is hugely important.
The long-term strength
Diageo is well known for its brands. But while these are category leaders in a lot of cases, I think the company’s real strength is its distribution network.
General John J. Pershing is known for saying that “infantry wins battles, logistics wins wars”. And I think something analogous is true of beverages.
The right products create short-term wins. But being able to distribute better than any other business is the biggest long-term advantage.
Diageo’s route-to-market relationships in 180 countries mean it can push the right products — low-alcohol, ready-to-drink, whatever — to consumers. And that’s not something that can be copied easily.
The GLP-1 problem
Investors seem hyper-focused on weight-loss drugs right now. And it’s certainly something to think about in the context of Diageo shares.
Morgan Stanley reckons GLP-1 use could cut alcohol consumption by up to 75% among patients. And Terry Smith sold his Diageo stake over exactly this concern.
There’s no denying the challenge. But I’m not sure the target market for each group is the same.
GLP-1 users tend to be an older demographic, but Diageo’s premium spirits drinkers tend to be a bit younger. So the overlap might be smaller than headlines suggest.
Worth buying?
Diageo shares are a strange one. I’m convinced the stock is either at the start of a comeback, or heading for a once-in-a-lifetime challenge – but it’s really hard to know which.
Weighing the low valuation, signs of recovery, and durable strength against the threat of GLP-1s is difficult. For now, I see this as one to watch closely, rather than a screaming buy.
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Stephen Wright owns shares in Diageo.
