When the Diageo (LSE: DGE) share price fell below 2,500p in late June, many investors thought the stock was a bargain. Today however, it’s still trading below this level.
Is the stock dead money? Or can it rebound to levels it has traded at in the past? Let’s discuss.
Multiple challenges
It’s no secret that Diageo’s currently facing multiple challenges. For starters, a consumer slowdown has hit demand for top-shelf booze.
Second, the company has had to deal with excess inventory issues in Latin America.
Third, weight-loss drugs such as Wegovy and Ozempic – which are huge in the US where Diageo generates a lot of its revenues – appear to be having a negative impact on demand for spirits.
Finally, younger people appear to be drinking less.
All of these factors were reflected in Diageo’s full-year results posted in late July.
For the year ended 30 June, organic net sales declined 0.6% year on year while earnings per share (EPS) before exceptional items were down 9%.
Dead money in the short term?
Given these challenges, and the lack of growth, I think the stock could be dead money in the near term (ignoring the 3.2% dividend yield).
Personally, I can’t see it rising significantly until management shows it has a handle on these issues and that the company’s back on track to hit its goals (it’s targeting 5-7% annual organic growth in the medium term).
Currently, the forward-looking price-to-earnings (P/E) ratio here is about 18, which is above the market average. For the valuation to rise in the near term, I think we would need to see more growth from the company.
More potential in the long term
Taking a longer-term view however, I’m more bullish on Diageo shares. Despite weight-loss drugs and new attitudes towards drinking, I still believe there’s going to be significant demand for Diageo brands such as Johnnie Walker, Tanqueray, and Baileys in the future.
And I can see the company’s revenues, profits and share price rising.
It’s worth noting that in the July commentary for his UK equity fund (Lindsell Train UK Equity), star portfolio manager Nick Train said he believes Diageo could be valued at up to 33 times EPS in the future given the calibre of its brands and the fact that it generates a large chunk of its revenue in the US.
Given that the EPS forecast for this financial year’s currently about 137p, that gives us a hypothetical price of about 4,500p – about 84% higher than the current share price.
We would not even consider selling out of an asset as advantaged as Diageo at anything less than a 30x or more multiple. We have added to our holding when we can.
Nick Train
Of course, there’s no guarantee the shares will ever get to that price. For the share price to rise to that level, the company will have to get its strategy right in a world where people are drinking less.
As a long-term investor in the company however, I’m optimistic it can do so. So I will be holding on to my shares.
This post was originally published on Motley Fool
