Diageo (LSE: DGE) (NYSE: DEO.US) shares have fallen by 12% so far this year, as the firm’s growth has tailed off, while profits have been hit by currency weakness in emerging markets.
The drinks firm’s share price hasn’t been this low since 2012 — so is now the time to buy, or is there worse to come?
I’ve taken a closer look at Diageo’s performance and valuation to find out more.
Valuation
Let’s start with the basics: how is Diageo valued against its past performance, and the market’s expectations of future performance?
| P/E ratio | Current value |
|---|---|
| P/E using 5-year average adjusted earnings per share | 19.3 |
| 2-year average forecast P/E | 16.6 |
Source: Company reports, consensus forecasts
Diageo is not cheap, but the firm’s above-average profit margins, rapid acquisition-led growth and high returns on capital have always been seen as justifying its premium valuation.
However, sales and profits fell last year, thanks to currency headwinds and slowing economic growth in key markets such as China. Is there an underlying problem?
A closer look
I’ve taken a closer look at Diageo’s growth record to try and gauge whether the firm’s medium-term growth prospects remain strong:
| 5-year compound average growth rate | Diageo |
|---|---|
| Sales | 1.0% |
| Operating profit | 1.0% |
| Dividend | 6.3% |
| Book value | 11% |
| Net debt | 3.1% |
Source: Company reports
These figures present a mixed picture. On the one hand, last year’s fall in sales and profits wiped out most of the gains seen between 2010 and 2013.
However, this could be a short-term dip — Diageo’s underlying value creation is more clearly illustrated by the fact that book value has risen by an average of 11% per year over the last five years, while net debt has only risen by an average of 3.1% each year.
This suggests to me that Diageo’s acquisitions are paying their way and helping to fund new growth, rather than just bloating up the business.
On this basis, Diageo looks increasingly good value. Over the medium term, sales and profits should recover and deliver fresh growth, while, in the meantime, the firm’s rising dividend will reward patient shareholders.
Has Diageo bottomed out?
If you’re a Diageo shareholder looking to top up, you’ll probably be hoping to wait until the company’s share price has bottomed out, before buying.
I’m planning to add some of the drinks firm’s shares to my portfolio later this year, and although I’m hoping that the firm’s share price will continue to fall, I’m not really sure if that’s likely.
My decision to buy is based on Diageo’s prospective yield, which has now risen to 3.2%. In my view, that makes these shares cheap enough to buy — although you may not agree.
