In general, I look to focus my investing on companies with truly exceptional attributes. That means I’m only really interested in a handful of FTSE 100 shares.
It’s rare to find these stocks trading at bargain prices. But in the case of Diageo (LSE:DGE), I think there’s an opportunity with the share price at a 52-week low.
Economics
Diageo’s dominant position in the spirits industry allows the business to maintain some impressive economic characteristics. The first is returns on equity (ROE) and the second is cash conversion.
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Over the last 10 years, the company’s managed to achieve an average ROE of around 28%. That’s significantly higher than the FTSE 100 average of 11%.
Cash conversion’s also impressive. Around 33% of the cash the business generates through its operations is used in capital expenditures, meaning 67% becomes available to shareholders.
It’s no accident Diageo has these attractive properties. With some of the leading brands in a number of categories and a huge distribution network, it has some durable advantages over its competitors.
Cyclicality
Despite its attractive properties, the Diageo share price has been going down. The stock fell 5% in May, while the FTSE 100 advanced 1.3%.
The main reason seems to be macroeconomic pressure. Weak consumer spending has been weighing on sales in Latin America and the Caribbean and there’s a risk of something similar happening in the US.
Most of Diageo’s portfolio is focused on the premium end of the market. And with no real switching costs, the company has no real way of stopping customers trading down.
The big risk is that the trend towards premium spirits that emerged over the last few years might not prove durable in a world with higher interest rates. But it’s not all bad news for shareholders.
Reasons for optimism
Last month, pub group JD Wetherspoon issued a trading update. The company noted that sales of Guinness – Diageo’s beer product – had been growing strongly, especially outside its traditional customer base.
Guinness accounts for around 20% of Diageo’s total revenues. So growth in this area might go some way towards offsetting weak sales in other categories.
Wetherspoon’s chairman Tim Martin put this down to fashion. But I think there’s something more significant than this for investors to take note of.
The increased popularity of Guinness might be the result of consumers being more price conscious at the moment. And this indicates Diageo has a portfolio that can generate growth even in a downturn.
A stock for all seasons
Investors are justifiably wary about consumers trading down from premium products. But I think the market’s underestimating the resilience of Diageo’s portfolio.
Growing Guinness sales should help stabilise revenues in the short term and I expect the firm’s strong position to generate good returns over time. That’s why I’m buying the stock at today’s prices.
