How Much Higher Can Diageo plc Go?

Right now I’m looking at some of the most popular companies in the FTSE 100 and wider market to try and establish which direction their shares are likely to move.

Today I’m looking at Diageo (LSE: DGE) (NYSE: DEO.US) to ascertain if its share price will continue to rise.

Market sentiment

As the world’s leading producer of alcoholic beverages, Diageo by its very nature is a defensive company, and the market is cautiously optimistic about Diageo’s future prospects.

One of the reasons behind positive investor sentiment are events currently unfolding within India. Specifically, India’s new Prime Minister-elect, Narendra Modi, has promised to open up India’s economy and make it easier for international groups like Diageo to operate within the county.

With Diageo looking to expand its Asian presence through the acquisition of India’s United Spirits, Mr Modi’s election should hopefully make it easier for Diageo to grow within the region.

However, investors are concerned about Diageo’s slumping sales within Asia as, historically, Asian sales have been Diageo’s growth engine.  Diageo reported a 19% decline in sales to Asia during the first quarter of this year. 

Still, during the first quarter of this year sales in North America, Diageo’s biggest and most profitable market, rose 1.2% and within Latin America, Diageo’s sales jumped 28% during the same period. So, it’s not all bad news. 

City expectations

Unfortunately, due to the recent emerging market turmoil, the City has lowered its outlook for Diageo.

Indeed, at the beginning of this year City analysts expected the company to report earnings per share of 105p and 115p for 2014 and 2015 respectively. However, the City is now forecasting that Diageo will report earnings of 99p and 107p per share for the next two years, around 6% less than originally predicted.

Actually, these figures now suggest that Diageo’s earnings will fall 8% this year, which is worrying as Diageo currently trades at a historic P/E of 18.6. A P/E multiple as high as 18.6 is usually assigned to growth companies and implies that if Diageo fails to meet growth targets, the company’s shares could slump.

Possible headwinds

The largest headwind facing Diageo going forward is the possibility of further political instability within emerging markets.

Further, as the majority of Diageo’s sales are conducted overseas, the company has to convert its earnings back into sterling and a strong pound is putting pressure on the company’s bottom line.

That being said, it seems as if Diageo, like many of its peers, is set to benefit from the 2014 FIFA World Cup in Brazil. Indeed, as mentioned above, Diageo’s sales within Latin America have already started to surge in the run up to this much anticipated sporting event. 

Foolish summary

Overall, Diageo is facing many headwinds going forward but the company’s global presence and defensive nature mean that it is well placed to ride out any short-term instability within emerging markets. Diageo should also benefit from improving economic conditions within India, one of the world’s largest consumer markets. 

All in all, I feel that Diageo’s shares will continue to rise. 

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In the meantime, please stay tuned for my next verdict.

Rupert does not own any share mentioned within this article.