Is it the perfect time to buy Diageo shares?

Diageo shares were punished after its recent half-year trading update. But with its market dominance, Stuart Blair looks at whether it’s now time to buy.

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Diageo (LSE: DGE) shares have always been a favourite in the FTSE 100. This has been thanks to a history of rising sales and dividend growth. But even the drinks giant has not been invincible to the impacts of coronavirus, with many unimpressed by the recent half-year results. This has seen its share price fall nearly 20% year-to-date. Even so, with a leading market position in 180 different countries, and significant brand loyalty, is this just a slight blip in a very bright future?

First-half trading update

Operating profits for the firm fell by 47.1% to £2.1bn. This demonstrated the impact of the closure of pubs and bars around the world, and management’s decision to write down some assets by £1.3bn. The business was most heavily affected in Africa, where operating profits totalled just £101m, a 63% decline from last year. This fairly gloomy trading update saw Diageo shares fall by more than 6% on the day.

But there were glimmers of hope as well. For example, in North America, operating profits rose by 4% from last year. This was due to the fact that the majority of consumption in the US is at home, and therefore sales were able to rise.

The group has also recently acquired Aviation Gin for £466m. This is a fast-growing brand within the US and represents Diageo’s continued market dominance. Such a large range of different products should therefore help harness further growth in the future.

Are Diageo shares a good income stock?

A sign of Diageo’s confidence was the decision to lift the dividend by 2%, despite the difficult trading conditions. As a result, the dividend now yields over 2.7%. This demonstrates confidence that the firm is well-positioned to recover strongly. In fact, CFO Kathryn Mikells has already spoken of an improvement in July.

Nevertheless, I do slightly worry about amount of debt on the Diageo balance sheet. Over the year, net debt has risen from £12.1bn to £14bn and is now 3.3 times cash profits. It also gives Diageo shares a debt-to-equity ratio of nearly 200%. This should restrict its ability to return capital to shareholders until the amount of debt is reduced. For example, it has already restricted share buybacks for the time-being, and unless profits grow strongly throughout the rest of the year, a dividend cut could be next.

Would I buy Diageo shares?

Fortunately, I don’t believe that this should be a problem. While I normally avoid stocks with such a large amount of debt, Diageo’s quality is simply too tempting. With over 200 different products, ranging from Captain Morgan to Baileys, Don Julio, Tanqueray, Guinness and Smirnoff, the drinks giant is evidently very diversified. A focus on innovation has also allowed the group to grow new brands and further increase sales within some of the more renowned brands. Consequently, this slight dip in the Diageo share price seems to provide a perfect time to buy.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stuart Blair owns shares in Diageo. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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