Is Now The Time To Buy Diageo?

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By

Rupert Hargreaves

Published in Company Comment on 11 January 2013

Should you buy Diageo plc (LON:DGE) today?

I'm always searching for shares that can help ordinary investors like you make money from the stock market.

So right now I am trawling through the FTSE 100 (UKX) and giving my verdict on every member of the blue-chip index. Simply put, I'm hoping to pinpoint the very best buying opportunities in today's uncertain market.

Today I am looking at Diageo (LSE: DGE) (NYSE: DEO.US) to determine whether you should consider buying the shares at 1,790 p.

I am assessing each company on several ratios:

Price/Earnings (P/E): Does the share look good value when compared against its competitors?

Price Earnings Growth (PEG): Does the share look good value factoring in predicted growth?

Yield: Does the share provide a solid income for investors?

Dividend Cover: Is the dividend sustainable?

So let's look at the numbers:

StockPrice3-yr EPS growthProjected P/EPEGYield3-yr dividend growthDividend cover
Diageo1,790p30%17.61.82.4%14%2.2

The consensus analyst estimate for next year's earnings per share is 103p (10% growth) and dividend per share is 48p (10% growth).

Trading on a projected P/E of 17.6, Diageo appears cheaper than its peers in the Beverages sector, which are currently trading on an average P/E of around 23.8. Unfortunately, Diageo's P/E and double-digit near-term growth rate give a PEG ratio of around 1.8, which implies the share price is overpriced for the near-term earnings growth the firm is expected to produce.

Diageo offers a 2.4% yield, which is around the same as the Beverages sector average. However, Diageo has a three-year compounded dividend growth rate of 14%, implying the payout could soon overtake that of its peers.

Indeed, the dividend is more than two times covered, giving Diageo plenty room for further payout growth.

Strong historic growth but is this sustainable?

Despite Diageo's strong historic growth, I cannot see any signs of the company slowing down. You see, although Diageo has reported slowing sales demand within Europe and the US, the company has experienced increasing sales on all other continents. Indeed, in this year alone, sales in Africa grew 11% following 9% growth last year.

In addition, the majority of Diageo's growth during the past few years has been driven through acquisitions. For instance, in November, Diageo became a 53% shareholder in United Spirits -- India's largest drinks company.

Unfortunately, Diageo is currently having some bad luck with its acquisitions. In particular, I have discovered that Diageo's investment in United Spirits is being stalled by regulations within India. In addition, Diageo's attempt earlier this year to buy Mexican tequila specialist Jose Cuervo failed and a 25-year-old distribution agreement between the two companies broke down as a result.

Nonetheless, the company is also focused on organic growth. Indeed, Diageo has announced this year a £1 billion investment to increase its production of Scottish Whisky -- a market Diageo believes will grow 50% over the next 10 years.

So overall, based on Diageo's prospects for future growth and its current discount to its sector peers, I believe now looks to be a good time to buy Diageo at 1,790p.

More FTSE opportunities

As well as Diageo, I am also positive on the FTSE shares highlighted in "8 Dividend Plays Held By Britain's Super Investor". This exclusive report reveals the favourite income stocks owned by Neil Woodford -- the City legend whose portfolios have thrashed the FTSE All-Share by 200% during the 15 years to October 2012.

The report, which explains the full investing logic behind Mr Woodford's dividend strategy and his preferred blue chips, is free to all private investors. Just click here for your copy. But do hurry, as the report is available for a limited time only.

In the meantime, please stay tuned for my next verdict on a FTSE 100 share.

> Rupert does not own any share mentioned in this article.

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Comments

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Excel35 11 Jan 2013 , 2:38pm

You think now is a good time to buy?

The share price has increased 27% in the last 52 weeks.

According to digitallook, the yield between 2008-2011 3.2%- 4.1%, its now only 2.4%

The p/e between 2008-11 was 12.5-15.2, now its stating 19.0

During 2011, there were 2 opportunties to pick it up for around 1150, its now well over 50+% above those prices.
Going back further in time, you could have just got it cheaper and cheaper.
Is the company worth 50% more, have growth prospects dramactically improved? Was it previously significantly undervalued? No.

What has fundamentally changed for this stock to be worth way more now than ever before? Nothing.

There will surely be better times to pick up this stock, much better times.

This is a prime example of a company that was/is in favour, certainly in 2012. I'm hoping it gradually falls out of favour, as its the sort of company I'd like a holding in, but buying in at a decent price.

Patience.

ANuvver 11 Jan 2013 , 4:38pm

I think the Guardian tipsters have this down as a play on US recovery. That is, of course, the Guardian City desk, which is a bit like the Stuttgart Chapter of UKIP...

Definitely a "hold", not an "accumulate". And I say that with all honesty, as someone who's sitting on most of that 50%+ that Excel mentions.

Maybe I'm anchoring, but I'm cagey about DGE upside at this level, even when it's attached to possibly the most eternal defensive market of them all. A propos the Graun's tip, they may have a point, but I've witnessed first-hand the way people lap up their brands in KL, Sing, etc. An affluent Asian dinner table is just unthinkable without a bottle of Johnnie Walker in the middle...

F958B 11 Jan 2013 , 7:35pm

US recovery?

With Obama having accumulated more debt than all US presidents before him combined, the US hasn't even begun to bring its debts and deficits under control. With such a debt and deficit burden, recovery is going to be slow and erratic at best, and non-existent at worst.
When Congress recently faced the "fiscal cliff" they begun to behave in the same way as the Europeans with their PIIGS crisis; kicking the can down the road and hoping that "something comes up" and it fixes itself, or that someone else will make the tough decisions for them at a later time.
Of course, most likely is that they will do the right thing - but only after exhausting all other options; travelling to hell and back in the process.

As for Diageo: good company, but significantly overpriced.
Long-term average growth of 6% p.a. and a 2% dividend yield is not worth a P/E in the high teens. Only market fashion keeps them popular.

DGE, trading at 1.5x the FTSE median valuation, are reminiscent of the similar relative overvaluation state of Glaxo or Vodafone in the early 2000's - both of which performed poorly in share price terms despite god operational performance.

If DGE continue that long-term 6% growth trend, it'll take about ten years of growth in earnings and dividend and a static share price for the valuation to converge with the current FTSE median P/E and yield.

I'd put DGE near the top of my list for companies whose shares underperform in the next 5-10 years due to being so expensive to start with.

MySockBrokeHer 12 Jan 2013 , 6:11am

If rather own tullet prebon with a nice 6% yield and very low p e

ANuvver 12 Jan 2013 , 12:12pm

F:
Wasn't saying I agree with the Graun tip (and of course, they have a vested interest in shouting up the Obama agenda). The City hacks are a beleaguered lot though, operating in an editorial environment that looks for an "evil capitalist scum" angle on a "kitten up tree" story.

Sad news about Araucaria, for those cruciverbally inclined.

ANuvver 12 Jan 2013 , 12:16pm

... and as we've discussed elsewhere, at least the Congressional behaviour over cliffs and ceilings might take some of the smug out of US sails when it comes to criticising the efficacy of other political systems...

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