Diageo plc: Everybody Needs A Drink At Christmas

Seasonal spirit

Diageo (LSE: DGE) (NYSE: DEO.US) has been a great long-term hold for me, rising 60% in three years, but 2013 was disappointingly flat. After peaking at 2,135p in August, its share price has dipped 11% to 1,899p. If that doesn’t fill you with the Christmas spirit, be of good cheer, because there are still good reasons to stick with Diageo.

After a blistering burst of growth, it was inevitable that Diageo would suffer a hangover, but I admit the recent slip in sales in China and Russia was dispiriting. China suffered a sharp fall in net sales in Diageo’s Chinese white spirit subsidiary, as the authorities cracked down on lavish entertaining. Sales in Russia also fell, although that followed a very strong comparative quarter in the previous year. Fears of a wider slowdown in emerging markets has weighed heavily on the share price. As have concerns over the decision by new chief executive Ivan Menezes to ditch the aggressive acquisitions strategy that served his predecessor Paul Walsh so well. 

Brand power

Rather than getting the world to drink more, Menezes wants it to drink better, and aims to do this by investing in Diageo’s premium brands. While this won’t provide the instant kick that a new acquisition can give the bottom line, building on the success of global brands such as Johnnie Walker Black Label, Baileys and Smirnoff seems a wise strategy. Diageo’s product range includes six of the top 20 premium spirits worldwide, according to Databank, and 16 of the top 100 brands. Brands such as Gordon’s, Tanqueray, Captain Morgan, Pimm’s, Guinness and Red Stripe add to Diageo’s impressively-stocked drinks cabinet. Its core US spirits market, the largest part of its business, is still holding its own with sales growth up 5.1% in Q3.

My regular gripe about Diageo is the yield, currently just 2.5%. That reflects its recent share price success, which has also forced up the valuation to a pricey 18 times earnings. This is a premium company, with premium brands, trading at a premium price. I can’t recall the last time it looked cheap by traditional measures. I don’t expect Diageo to repeat its success of the past five years, during which time the share price doubled, especially with earnings per share on a modest forecast of 4% in the year to June 2014. 

Spirit of Christmas future

Credit Suisse’s recent decision to cut its target price from 2350p to 2200p reflects this stock’s more sober outlook, but its new target is still 16% above today’s price of 1899p. Diageo is now a self-described “medium-term growth share”. You might find fizzier seasonal fare out there, but it should serve you well for plenty of Christmases to come.

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> Harvey owns shares in Diageo.