Three years ago, Diageo (LSE:DGE) shares were performing admirably. The leading alcoholic beverages business delivered fairly consistent organic growth supported by its global portfolio of brands, including Johnie Walker, Guinness, and Smirnoff.
Yet with the rise of inflation, that all changed. Macroeconomic weakness around the world, triggering a cost-of-living crises here in the UK and abroad, sent spending on discretionary premium products tumbling. This shift in consumer behaviour was particularly prevalent in Diageo’s key markets in Europe and the US.
This persistent pressure’s only been compounded by rising trade uncertainty as well as turnover in the C-suite, with Debra Crew taking over as CEO in July 2023, only to step down earlier this year.
The result? Since the start of November 2022, Diageo shares have lost 54.3% of their value. And as such, a £5,000 initial investment three years ago is now only worth £2,285 – a painful loss.
But what if Diageo shares have now become a golden buying opportunity?
A premium brand at a discounted price
The downward pressure on Diageo shares has continued this month, with investors once again disappointed with the group’s latest results. But as a consequence, the FTSE stock’s now trading at a level not seen since 2015 with a dirt cheap forward price-to-earnings ratio of just 11.6.
It seems investors have lost almost all hope for this business. And while there are some justifiable reasons to be concerned, the pessimism surrounding Diageo may have become overblown.
Despite all the challenges the company’s facing, it nonetheless owns some of the world’s most iconic brands, granting a discernible competitive advantage and pricing power. During economic downturns, it’s challenging to utilise this competitive edge. But when conditions eventually recover, premium consumer spending’s likely to follow.
This eventual cyclical shift acts as a natural recovery tailwind for Diageo’s business. But with the company streamlining operations to deliver permanent annualised savings, it could emerge from this storm as a far leaner and profitable enterprise.
In fact, we’ve seen almost the exact same scenario happen before. During the 2008 financial crisis, Diageo’s sales, earnings and share price collapsed as discretionary consumer spending came to a grinding halt. Management responded with aggressive cost control measures. And once economic conditions recovered, so did Diageo.
So can it do it again?
Time to buy?
Past performance doesn’t guarantee future returns. And today, Diageo has a very different management team compared to over a decade ago.
With Crew stepping down in July, the company still doesn’t have a permanent leader to set a new vision or outline a recovery strategy. Nevertheless, previous cost-cutting initiatives continue, and the company appears to remain on track to deliver $3bn of free cash flow by the end of 2026.
Assuming this goal’s hit, that provides whoever moves into the corner office ample financial flexibility to pursue their own turnaround plan as well as reduce leverage on the balance sheet.
This obviously all comes with significant execution risk. And for now, investors are holding Diageo shares on a very short leash. But with the valuation now sitting in discount territory, that’s a risk that might be worth taking. As such, I think long-term value investors may want to investigate this opportunity further.
But it’s not the only potential bargain buying opportunity out there right now.
