Could Diageo plc & Fevertree Drinks PLC Be The Tonic Your Portfolio Needs?

If ever a stock pairing was made for each other, then it should be these two. Gin & tonic is the hipster tipple of choice these days, as the once-fusty-but-always-fabulous drink storms back into fashion. So why not combine a dash of global drinks giant Diageo (LSE: DGE) with a splash of tonic maker Fevertree Drinks (PLC: FVER)?

Drink problem

Premium drinks business Diageo serves up a lot more than Tanqueray gin, its other giant global brands include Johnnie Walker, Smirnoff, Captain Morgan, Baileys and Guinness. Yet recent share price performance has been weak, with the stock down 5% over the last three years. I sold my stake around in 2013 after deciding that the glory growth years under departing chief executive Paul Walsh were over. Successor Ivan Menezes has still to convince me otherwise.

Revenues slipped slightly in the six months to 31 December, from £8.72bn, partly due to adverse currency movements and the offloading of £400m of non-core assets. Pre-tax profit did edge up from £1.64bn to £1.78bn year-on-year and Menezes hailed growing volumes, improved key brand performance and strong cash flows. Yet I still can’t recapture my taste for this stock.

Growth potential is tight as Chinese authorities curb gift-giving and emerging market consumers no longer feel so flush. The US has also been sluggish, which makes me wonder whether Diageo is on the wrong end of a trend. Western consumers increasingly seek quality over quantity as the foodie fad extends to the drinks trade: artisan gins now trump the old duty-free favourites. To be fair, Menezes has countered this with his Drink Better premium brands strategy, but Diageo faces stiff competition.

Tree of life

Rather than reacting to changing drinking trends, Fevertree Drinks is driving them. Its Indian Tonic Waters claim to only contain “the highest quality natural ingredients”, shunning the artificial sweeteners, preservatives or flavourings found in mainstream brands. And the foodies (or drinkies) love it. Fevertree has been awarded Cool Brands Status for four consecutive years and aims to launch a new product each year. Just glancing at its website made me feel thirsty.

Fevertree is more than just a cool brand, with its recent trading update anticipating a 77% rise in second half sales and 71% growth in revenues to £59.2m. UK sales (up 84%) are leading the way but I’m glad to see it making inroads into the larger US and European markets, with sales up around 65% in both. Diageo, by comparison, has been forced to dispatch its former CFO to turn things around in the US. It expects sales to rise 8.5% but that looks pallid compared to Fevertree’s flush of growth.

Diageo’s share price has been flat over the last year while Fevertree is up a sparkling 195%, making it a pure momentum play. It has repeatedly beaten its own expectations but its sky-high valuation of 203 times earnings means it must continue to do so.

After writing this I fancy a heady mix of Tanqueray and Fevertree myself, but as it’s still morning I’ll keep a clear head and raise my glass to Fevertree.

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