Was I mad to invest in Diageo (LSE:DGE) recently with the share price near a five-year low? Actually, it was more like a 14-year low, with the FTSE 100 stock trading higher in June 2012 than today.
I must be mad. After all, Diageo has been the ultimate falling knife — or beer glass — in recent years. Just when you think it’s reached a bottom, that it’s safe to touch, it falls further and splashes red ink across your portfolio.
What’s more, I can’t help noticing how packed my local gym is nowadays, even on weekends when most young people used to be out drinking. There are certainly more road cyclists with their lean physiques to navigate.
Then there are Zumba, Pilates, Tabata, and other classes with strange names. And it’s not just here, as Fortune Business Insights projects that the global health and fitness club market will hit $298bn by 2034, up from $131bn last year.
Clearly, there’s a shift going on with regards to people drinking less alcohol. And it’s Gen Z leading the fitness charge.
Then again, my local pub was recently packed for the England games. Every other person was drinking Guinness — arguably Diageo’s flagship brand now — or gin cocktails, probably made with Gordon’s or Tanqueray (two of its other timeless brands).
So I’m torn on whether alcohol’s going the way of cigarettes or just in a cyclical downturn due to the cost-of-living crisis.
What do the experts reckon?
It seems like analysts are split, too. According to UBS, the key US spirits market is unlikely to strengthen anytime soon, and could even weaken faster than expected over the next year.
Still, while UBS maintains a Neutral rating on Diageo stock, it did slap a 1,600p price target on it. That’s slightly higher than the present share price, suggesting most of the negativity might be baked in.
The average price target among 21 analysts backs this up, as it’s currently 23.5% higher.
Reasons for optimism
Speaking personally, I’d snap your hand off for this return in 12 months’ time. But I haven’t invested to try and make a quick buck (or pound). I appreciate this is a multi-year turnaround operation, and I’m willing to be patient.
What gives me confidence it can be achieved? Well, Diageo still has a core portfolio of world-class drinks that are likely to command brand loyalty for decades. I’m thinking about the likes of Johnnie Walker and Guinness, which is growing in all geographic regions.
For the current fiscal year (which ended in June), Diageo expects operating profit to be flat, or grow in the low-single digits. It also expects free cash flow of about $3bn, so there does appear to be a baseline here that can be built on.
Additionally, turnaround specialist CEO Dave Lewis slashed the dividend earlier this year, creating more financial flexibility to chip away at the debt pile. Diageo also got $2.3bn for its stake in East African Breweries, a move likely to further strengthen the balance sheet.
Finally, the forward price-to-earnings ratio’s a lowly 13. At this depressed valuation, I think the stock’s worth considering, despite the obvious risks.
But for investors still unsure, Diageo’s Capital Markets Day is scheduled for 6 August. We’ll learn more about management’s turnaround strategy then.
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Ben McPoland owns shares in Diageo.
