The Pros And Cons Of Investing In Diageo plc

Stock market selections are never black-and-white decisions, and investors often have to plough through a mountain of conflicting arguments before coming to a sound conclusion.

Today I am looking at Diageo (LSE: DGE) (NYSE: DEO.US) and assessing whether the positives surrounding the firm’s investment case outweigh the negatives.

Sales streaking higher

The beverages giant has a stellar record of punching steady global revenues growth, a point borne out in last month’s interims, which revealed that net organic revenues rose 3.1% during July-September.

On top of 5.1% growth in its number one market of North America, the company also saw turnover in Latin America and the Caribbean leap 10.9% during the period. In addition, the firm reported solid growth in other emerging markets, with sales in Africa, Eastern Europe and Turkey rising 1.3%.

Europe continues to drag

Still, concerns have abounded that the company is experiencing marked sales slowdown in its key markets, and net organic revenues growth in the first quarter was far below the 5% seen in the corresponding three quarters in 2012.

Most worryingly, the company continues to see its fortunes decline in the critical Western European territory, which is responsible for almost a quarter of group sales. Turnover here slipped 1.1% during July-September, Diageo noted, and continued economic difficulties in the region could keep dragging demand lower.

Bank on bumper brands

But Diageo has a premier stable of top labels, which have the capacity to propel earnings higher despite the effect of broader economic travails on consumers’ pockets. Indeed, the firm’s portfolio of top brands, which includes the likes of Guinness, Johnnie Walker and Smirnoff, boasts considerable pricing power that is keeping revenues moving higher.

Furthermore, these prime labels are proving indispensible in allowing Diageo to keep moving its margins higher, a critical feature in the event of further demand weakness. The business saw margins rise 0.8% during the year ending June 2013, a result which drove operating profit 8% higher to £3.53bn.

Not a cheap selection

But for some, signs of slowing growth rates in some of its key regions are yet to be reflected in the company’s share price, and Diageo can hardly be considered a bargain buy.

The beverage house currently deals on a forward P/E multiple of 18.4, far ahead of the value threshold of 10 or below. And a prospective price to earnings to growth (PEG) reading of 4 falls way outside the best-bang-for-your-buck benchmark of below 1.

A stunning share selection

Still, in my opinion Diageo’s fantastic record of delivering steady annual earnings growth justifies its premium rating. I am convinced that the firm’s exceptional list of market-leading brands should keep both revenues and margins moving higher, even if pressure on customers’ spending power persists. And I reckon its expanding presence in key developing regions should underpin long-term growth, as economies here regain traction.

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> Royston does not own shares in Diageo.