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Diageo plc: The Most Expensive Double You’ll Ever Buy

659px-DIageo_Logo.svgAs stock markets enjoyed a spirited rebound after the financial crash, the party was in full swing at global drinks giant Diageo (LSE: DGE) (NYSE: DEO.US). The stock eventually became a two-bagger when its share price hit a high of 2136p exactly one year ago today. Doubles all round! After all the fun, however, a hangover was inevitable, and Diageo is down almost 18% over the past 12 months.

Glass Half-Full

If you reckon now is the time to buy Diageo at happy hour prices, you might want to think again. It may be cheaper than it was, but it still trades at a relatively pricey 18 times earnings, against 13.5 times for the FTSE 100 as a whole.

That’s pretty stiff, given the challenges it faces right now.

Better Isn’t Always Better

Diageo was to die for under chief executive Paul Walsh. I was happy to hold it throughout his global acquisition spree, but I knew it couldn’t last forever. His successor, Ivan Menezes, rightly understood the company had to change course. The acquisitions slowed, as he focused on his new Drink Better strategy, which involved focusing the company’s firepower on its premium core brands. 

Once the rapid global growth prospects had drained away, I suspected the share price could struggle. And I was right. 

China Crisis

The last thing Menezes needed was for the Chinese government to crack down on gift giving and state-funded banquets as part of its anti-extravagance campaign, which hit sales of spirit brands. Sales of local firewater Shui Jing Fang fell 78%, recent full-year profits show. Tax hikes in South-East Asia and political unrest in Thailand also hurt. 

Diageo also suffered setbacks across Africa, Eastern Europe, Turkey, Latin America and the Caribbean. Investors who cheered its £4 billion dash for emerging markets growth now fear it was spending a little too enthusiastically.

US Rescue

Sterling’s recent strength hasn’t helped, given that Diageo generates so much of its earnings overseas. Net profits fell 8% to £2.25 billion, while revenues dropped by a similar percentage, to £13.9 billion.

If you’re investing in a globally diversified operation like this one, you have to take the rough with the smooth. Where one region underperforms, another is likely to compensate. Its key US market came to the rescue, where the fragile economic delivered 5% growth in spirits and wines.

Low Yielder

Diageo is also looking to save £200 million a year, by cutting costs and expanding margins. And I’m pleased to see that it has rewarded loyal investors with a 9% hike in the dividend to 32p a share, although at 3%, it continues to underperform the FTSE 100, which currently yields 3.55%.

For a company often touted as a safe dividend play, its yield has always long been underwhelming.

Double Down

Its valuation, on the other hand, has been high for some time. Back in February, it was trading at more than 20 times earnings, which is when I decided to sell.

This is now a sprawling global operation, and the days of rapid growth looked to be over for now. I wouldn’t expect Diageo to double anybody’s money in the near future, that valuation looks a little too pricey for me.

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Harvey Jones has no position in any shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.