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Diageo Plc Looks A Little Short Of Spirit

Diageo (LSE: DGE) (NYSE: DEO.US) has given my portfolio quite a kick in recent years, but performance hasn’t been so intoxicating lately. Over five years, it boasts total growth of 120%, almost double the return on the FTSE 100. But it is down 3.5% over the last six months, while the FTSE has risen 4% in that time. Can Diageo recapture that party feeling?

I began to worry about Diageo last autumn, when new chief executive Ivan Menezes signalled an end to the company’s aggressive acquisition strategy, which served it well during the rapid growth years. I don’t necessarily think this was the wrong decision: even an operation the size of Diageo can only stomach so much booze. Menezes had a new slogan to explain the strategy — “Drink Better” — as he looked to develop premium global brands such as Johnnie Walker Black Label, Baileys and Smirnoff. But that looks like a tougher, slower task than using its firepower to snap up rivals. It also suggests the nature of the stock is likely to change, from a growth investment to an income play.

Tequila slammer

If I’m right, that is a worry, because Diageo’s yield is weak as water. Right now, it yields just 2.4%, against the FTSE 100 average of around 3.5%. I’d like to think that would strengthen, especially if share price growth remains slow. Covered 2.2 times, there is scope for a progression. But the market has pencilled in a yield of just 2.8% by December 2015, so don’t hold your breath. This is still a stock you buy for its growth prospects.

On that front, the short-term doesn’t look so tasty. After three years of double-digit growth, earnings per share are forecast to slip to just 3% in the year to 30 June. But they should hit 10% in the 12 months to 30 June 2015, which suggests Diageo still has some fire in its belly. As does its recent link-up with rapper turned businessman Sean “Diddy” Combs. The two have set up a joint-venture to buy luxury tequila brand DeLeon, which can sell for more than $1,000 a bottle (although prices start at around $120). Rock stars and the Hollywood fast set can’t get enough it, I’m told.

Firewater

This isn’t the first venture for this unlikely combination. Six years ago, they bought premium vodka brand Ciroc, and lifted sales from 50,000 a year to two million in the process. Moving into ultra-premium brands certainly fits the “Drink Better” strategy, and suggests Diageo still has a bit of fire in its belly. The question is whether you would pay 19 times earnings for it. Both Nomura and Credit Suisse have recently reduced their target prices to 2200p, around 10% above today’s 1983p, while maintaining their respective ‘buy’ and ‘outperform’ ratings. I like a drink, but not at these prices.

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Harvey owns shares in Diageo.