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2 Resounding Reasons To Steer Clear Of Diageo plc

In recent days I have looked at why I believe Diageo (LSE: DGE) (NYSE: DEO.US) is an exceptional investment choice for any stock portfolio (the original article can be viewed here).

But, of course, the world of investing is never black-and-white business — it take a confluence of views to make a market, and the actual stock price is the only indisputable factor therein. With this in mind I have laid out the key factors that could, in fact, put Diageo’s investment appeal under the cosh.

Emerging markets on the slide

Diageo has long been viewed as a terrific stock for solid exposure to developing markets. But rising weakness in these key regions is becoming an escalating cause of concern, and the firm saw group organic net sales grow 1.8% during June-December, illustrating a slowdown from a 2.2% expansion during July-September.

The drinks giant derives around 48% of net sales from emerging geographies, meaning that signs of any slowdown — growth here decelerated to just 1.3% during the first six months of fiscal 2014 — is reason for serious worry.

diageoIn particular, the company’s Asian Pacific business was the worst performing of all of its territories, where organic net sales and volumes slumped 6% and 4% respectively in July-December. Particularly worrying was the significant demand decline in China, which Diageo attributed mostly to government measures to rein in extravagant official spending — these caused net sales to rattle 23% lower during the period.

But Diageo is also facing difficulties in other growth markets, with Nigerian organic sales declining 10% due to a contracting beer sector and the rising popularity of growth brands. And significant destocking in the West Latin America and the Caribbean sub-region prompted sales here to drop 14% during July-September.

Cash pile on the wane

Diageo has seen its sizeable cash pile plummet over the past year, mainly due to the vast amounts of capital being ploughed into marketing across the globe. Cash generated from operations collapsed to £1.17bn during July-December from £1.43bn during the corresponding 2012 period, while free cash flow crumbled to £326m from £708m over the same period.

With sales slowing across the group it appears as if Diageo will have to continue ploughing large sums into advertising and brand promotion in order to maintain an upward keel. Not only could this put the brakes on potential acquisition activity, but dividend expansion could also come under the cosh in the near future.

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Royston does not own shares in Diageo.