Diageo: Darkest Before the Dawn? Shares Near COVID Trough and <19x FY19 EPS

Company Update (DGE LN) (Buy): We believe EPS growth will return to high-single-digits and drive a 59% return by June-2027; Dividend Yield is 3.0%.

Highlights

• Shares of spirits makers have fallen to multi-year lows, including Diageo’s.

• Recent results show cyclical weakness, not reason to doubt structural growth.

• Diageo sales fell just 1.4% in Jul-Dec; Jan-Jun is expected to be better.

• Peers’ Jan-Mar results showed overall momentum, especially outside the U.S.

• At 2,643.5p, we see a 59% total return (16.9% p.a.) by June 2027. Buy.

Introduction

We revisit our Buy rating on Diageo after shares closed at a new 52-week low last week. Shares are now less than 10% above their March-2020 pandemic trough and show a P/E of less than 19x relative to pre-COVID FY19 earnings:

Diageo Share Price (Last 5 Years)

Source: Google Finance (03-Jun-24).

We have been wrong on Diageo. Shares have lost 13.2% (after dividends) in the 5 years since we initiated our Buy rating on Diageo in July 2019. Diageo has also been part of our “Select 15” model portfolio since its inception at the start of 2023, and currently shows an unrealised loss of about 16%. We have also lost money on Diageo in real life.

Shares of other Spirits companies, including Pernod Ricard, Rémy Cointreau and Brown-Forman, are also at multi-year lows. We believe investors over-reacted to weak growth in recent results and extrapolated that to be the long-term trend.

The key components of our Diageo investment case are that premium spirits companies will continue to grow sales at mid-to-high single-digits, margins will continue expanding, and FY19 was a relatively normal year. Recent sector results, while showing cyclical volatility inherent in the sector, remain consistent with these assumptions.

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