Alcohol giant Diageo (LSE:DGE) had an impressive showing in 2021, recording 31.8% returns in the 12-month period. The Diageo share price constantly pushed its all-time highs in 2021. But its shares currently looks overvalued at 4,060p, trading at a profit-to-earnings (P/E) ratio of 35 times.
But a company’s P/E ratio is not the only marker of future performance. As we saw this year, overvalued companies like Croda International still grew steadily despite inflated valuations. Will strong core financials and expansion efforts push Diageo higher in 2022 — or do I expect the company to face a long, sideways accumulation this year?
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Reason for success
After the drop-off in 2020, the alcohol market rebounded well. And Diageo made some shrewd moves during the pandemic to use excess cash towards expansion in key foreign markets. The company went on a targeted spending spree, amassing a lot of successful distilleries and brands in Asia and Africa.
I think Diageo’s use of data and processing algorithms to pinpoint potential purchases has been impressive. As a leader in the UK and US, the company managed to build on its premium offerings, given the segment’s quick growth in the last decade. The company is now the global leader in the premium categories and international spirits, with retail sales of over £4.5bn in the financial year 2021 (ended 20 June).
Ready to drink (RTD) cocktails is the fastest-growing alcohol category in the US, growing 42% between 2017 and 2020. Diageo’s new Crown Royal RTD cocktail line quickly became the third-largest spirits RTD brand in the US. As a result, the company also managed to raise cash in hand to £3bn in FY21. I think this is a sign of more expansion in emerging markets like China, India and Latin America.
Emerging market growth
This brings me to two key markets for Diageo. Over the next decade, it is estimated that China and India will collectively consume more alcohol than all of Europe combined. And China already leads most alcohol consumption charts, outstripping total sales of Germany, the UK and the USA combined!
The alcohol giant has identified both premium and cheap offerings in Asia while also targeting regional spirits that are growing in popularity. Diageo is amassing distilleries in Greater China that specialise in local spirits like Baijiu.
The company also used the pandemic pause very well by working on its eCommerce operations. Via partnerships with existing delivery companies in Asia, America and Africa, the company grew online sales by 70% last year. Although this accounts for a small fraction of total sales, I think it is a positive sign to establish a robust online sales framework for alcohol.
Concerns
While past performance is used to analyse a firm’s potential, it does not guarantee success. I think falling alcohol consumption levels across the world is a threat for Diageo. Youngsters are opting for healthier lifestyles, and alcohol consumption is falling in several key markets like the UK, Australia and Russia.
And Diageo is aiming for net-zero emissions across all operations by 2030. Given Diageo’s distillery network, I think this will be a cash-intensive operation. But I think Diageo has a strong brand portfolio and a blueprint for sustained growth. I am considering a £1,000 investment in the company in January because the Diageo share price could grow next year even if we are forced into another lockdown.
