Is the Diageo share price coiled to rebound?

Christopher Ruane explains why he remains bullish about the long-term outlook for the Diageo share price and would happily invest today.

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From a business model perspective, I think there is a lot to like about drinks maker Diageo (LSE: DGE). It has high profit margins, unique brands and a proven ability to generate cash.

But what has stopped me investing in the past is valuation. Often, I think the Diageo share price reflects the attractions of the business and so offers me no margin of safety as an investor. Indeed, if I had put money into the shares a year ago, I would now be sitting on a 19% paper loss.

There is a dividend, with a track record of annual increases stretching back well over three decades. But with a yield of 2.9%, buying the shares a year ago would still have proven ill-timed for me, given the current Diageo share price.

Even on a five-year timeframe, the FTSE 100 share has lost 8% while the benchmark index has moved up 7%. A great business does not always translate into a great investment – it partly depends on the price paid.

Still, could things be about to start moving in the right direction?

New leadership

The company appointed a new chief executive last year. Today (19 March), it announced the appointment of Sir John Manzoni as its new chairman, a well-regarded businessman who was once considered a contender for the top job at BP.

After a challenging year for the company, I am hoping this could boost investor confidence.

Diageo certainly has some work to do. Slowing consumer spending in Latin America contributed to a decline in both volumes and sales revenues in the second half of last year.

One of the benefits of owning premium brands like Talisker is that the company should ideally be able to offset falling volumes by putting up prices.

The fact that both sales volumes and revenues have been declining lately is a cause for concern. If Latin America is an early demonstration of what happens elsewhere as economies slow, there could be more bad news to come.

Indeed, I think that explains why the Diageo share price has fallen.

Long-term outlook

Just as a whisky like Talisker ages over many years, my approach to investing focuses on the long term.

I would not be surprised if Diageo faces a tough market over the next several years due to weaker consumer spending. However, new leadership will hopefully be assessing the company’s current strategy and how best to deal with the economic challenges.

Meanwhile, the company remains solidly profitable. Profit attributable to its shareholders in the final six months of last year fell 18% compared to the prior year period, but still topped $2bn.

Ongoing business appeal

The business has deep strengths, from its well-marketed premium brand portfolio and unique products, to a wide distribution network and large customer base.

I do not think its price-to-earnings ratio of 20 is cheap. But I think it is fair for such a great business. New leadership and any sign of improvement in business performance in this half could help boost the prospects for the Diageo share price. I think it could rebound if business results start improving this year.

If I had spare money to invest I would be happy to buy the shares today to hold for the long term.

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.

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo Plc. 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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