A while ago, I decided to take a chance on the FTSE 100 telecoms company Airtel Africa. In January 2024, the stock dropped 26% in the space of one month after an earnings call missed expectations.
While concerning, the profit miss was attributed to foreign currency fluctuations rather than operational issues. As I was familiar with the business and believed in its underlying strength, I felt confident it would recover.
It took some time but eventually a recovery kicked in and now it’s up almost 200% in just 12 months. That’s a juicy bit of profit — but I don’t expect it’ll do that again.
So that had me thinking — could there be a similar opportunity elsewhere? I think I’ve found one.
A potential recovery candidate
Although a vastly different business, I think Diageo‘s (LSE: DGE) in a position similar to Airtel a few years ago. It’s also taken a hit due to economic issues in emerging markets, many of which were historically beneficial for the company.
Down 35%, it’s one of the worst-performing stocks on the FTSE 100 this year. The losses are driven primarily by the same foreign exchange challenges that plagued Airtel — particularly in markets like Latin America, Africa and Asia-Pacific.
Additionally, it has taken an annual hit of between £100m-£150m due to US trade tariffs. These combined issues have resulted in unusually high losses that I feel don’t reflect genuine weaknesses in the business.
Cost savings
Like Airtel, Diageo has initiated an aggressive cost-savings initiative to try to mitigate losses. It recently launched a programme dubbed ‘Accelerate’, aimed at achieving £2.25bn in free cash flow from 2026 onwards, with £375m-£470m in expense reductions.
Despite the short-term challenges, Diageo’s fiscal 2025 results revealed organic net sales growth of 1.7%, with emerging markets delivering the strongest performance. India continues to benefit from growth in premium brands and Africa has delivered double-digit growth in Ghana, Tanzania and Uganda. Moreover, Latin America is already showing signs of recovery, with double-digit gains in Brazil.
A value play
The falling share price means Diageo stock now looks significantly undervalued, with a forward price-to-earnings (P/E) ratio of just 13. The stock is estimated to be trading at 45% below fair value using a discounted cash flow (DCF) model. As such, analyst consensus expects growth of around 28% on average over the coming 12 months.
Adding to the investment thesis is a 4.9% dividend yield with cash coverage of 1.9 times. That makes it attractive to both value and income investors.
But a strained balance sheet adds notable risk — with 1.6 times more debt than equity, it can’t afford to keep losing ground. If it’s going to make a recovery, it needs to be fairly soon — otherwise it could risk a dividend cut, or worse.
Final thoughts
Buying a stock that’s been falling for years is always a risk, as it may never recover. But despite the losses, Diageo still exhibits impressive profitability, with a return on equity (ROE) of 22.7%.
In its latest full-year results, it brought in £1.82bn in profit from £15.65bn in revenue, leaving it with thin margins, but sufficient to maintain operations. In my opinion, it’s worth considering as the potential reward could seriously outweigh the risk.
