The Diageo (LSE:DGE) share price has collapsed in recent years. From heights above £40 a share in 2021, the stock now trades under £17.
What pushed the shares so high in the first place? Well, investors were bullish on long-term trends towards branded alcohol consumption and opportunities for continued penetration in developing countries.
Coincidentally, weakness in developing markets has actually been part of the company’s downfall. Latin America and parts of Africa, which had been expected to deliver years of premium spirits growth, saw consumers trade down or cut discretionary spending as inflation and interest rates rose.
Interestingly, Diageo appears to be acting on that weakness now. The company is selling its stake in East African Breweries to Japan’s Asahi Group for £2.3bn. Reports also suggest its considering the sale of its stake in Shanghai-listed Sichuan Swellfun Co.
Worth more in parts
There’s a growing argument that Diageo’s individual businesses may be worth more on a standalone basis than as part of the wider group.
Premium brands such as Johnnie Walker, Guinness, and Don Julio generate strong margins and cash flows that could command higher valuation multiples if independently listed.
By contrast, within the conglomerate structure, these assets are diluted by slower-growing or more cyclical regions and categories.
A break-up could unlock value by improving capital allocation, sharpening management focus, and allowing investors to value each business on its own growth and risk profile.
This, at least, the argument I saw explained by a social media ‘finfluencer’ the other day. The problem is, while that might be the case, Diageo remains a group of brands.
The current valuation
That leads me to the current valuation and the current business. Yes, Diageo could offload more underperforming businesses and becoming a more attractive investment prospect, but we’ve got to assess what’s in front of us.
So, Diageo is currently trading around 13.4 times forward earnings (for the coming 12 months). That’s not overly expensive at face value, but there are other things to consider. The net debt position is sizeable at $21.8bn. Adjusting for net debt, the business is actually trading closer to 24 times forward earnings.
Now, that puts it at a premium to the wider market, but it’s broadly in line with Anheuser-Busch InBev. The difference is, InBev has a strong earnings forecast with that price-to-earnings (P/E) figure moving from 20.3 times (not adjusted for debt) in 2025, to 14.7 times for 2027.
Diageo’s forecast (not adjusted for debt) sees that forward P/E fall to 12.5 times for 2027. Not a huge improvement on where we are today.
Yes, Diageo’s dividend yield is above the index average at 4.6%. But dividend coverage has also fallen to around 1.6 times. Typically, a ratio above two is considered healthy.
My take
From what I know today, I don’t think there’s enough for the market to change its opinion on Diageo. And that’s why I don’t see a significant shift up this year. However, operationally things can change. It’s worth keeping an eye on that. Because, if it improves, it could be worth considering.
