In sharp contrast to the FTSE 100 index, the Diageo (LSE: DGE) share price has fallen nearly 9% in 2024 so far. In fact, it’s now touching lows not seen since the early days of the pandemic.
Is the company really doing that poorly or is the fall overdone to the point that the stock is now almost comically undervalued?
Sales have tanked
I think it’s fair to say that business could be better for the premium drinks firm.
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Having recovered strongly from the impact of Covid-19, Diageo has faced a fresh headwind in the form of the cost-of-living crisis. While this hasn’t turned everyone into teetotallers, it has succeeded in disrupting trade at key points of consumption, such as bars and restaurants. As well as drinking more from home, shoppers have also been turning to cheaper alternatives.
All this translates to lower earnings for the company. As evidence of this, sales fell a sobering 23.5% in Latin America and the Caribbean in the first half of the current financial year.
To be clear, Diageo hasn’t been suffering alone. Rival Pernod Ricard registered weaker-than-expected sales in its third quarter. More generally, pretty much anything with a luxury tint has been rocked by poor sentiment in recent times. Fellow FTSE struggler Burberry is an example.
But it’s hardly what one wants to see from a supposed ‘buy-and-forget’ investment.
Reasons to be optimistic
So, is Diageo doomed? Let’s not get silly.
Yes, alcohol consumption has been falling over the years and younger generations are generally more health-conscious. However, one can also argue that drinkers are simply becoming more selective and willing to splash the cash on upmarket brands when they do fancy a tipple.
If true, this is surely good news for the major players. With over 200 coveted brands in its portfolio, the probability that whatever it poured is made by Diageo will be pretty high.
Far from calling time on the company, I wonder if this trend could actually be a growth driver.
Speaking of growth, I’m also positive on the £57bn cap’s intention to focus on rapidly developing markets like China. As the middle class expands, there’s a huge opportunity to draw in new, rather than the previously-prioritised wealthier consumers.
Of course, one risk is that the economic situation doesn’t improve as soon as hoped, interest rate cuts are postponed (again) and the share price continues to stagger downwards.
No one knows for sure where stocks will go in the near term. But I do think this one looks great value on paper.
Bargain buy
Right now, I can buy a slice for the equivalent of 17 times forecast FY25 earnings. This is a far cheaper valuation compared to Diageo’s five-year average of 24 times earnings.
Owners will also be entitled to dividends that have been consistently hiked for many years. The yield currently stands at 3.1%.
Full-year numbers are due on 30 July. Despite inflation falling in recent months, I’m not convinced this will be reflected in revenue or profit just yet. However, I’m of the opinion that the worst is already over.
If I didn’t already hold a substantial position via various funds, I’d be queuing up.
