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Should I buy Diageo shares at its current price?

Shelves holding drinks bottles
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Diageo (LSE: DGE) shares are on the rise. The alcoholic beverage company was on my list of ‘stocks to buy in July’ and has continued its strong run. In the last 12 months, the stock has risen 22.59% and hit an all-time high last week.

Let us take a look at the factors driving Diageo’s growth and if I think it is worth buying at its current trading price of 3,410p with long-term growth in mind.

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Favourable conditions for growth

The pandemic resulted in a sharp decline in sales, and operating profits saw a decline for the first time since 2003. But as markets reopened, alcohol sales bounced back. The latest lift in UK lockdown restrictions allowed nightclubs to reopen, which gave Diageo shares a major boost. Also, the return of sporting and live music events in the country could further boost alcohol sales.

Even in Diageo’s international markets, restrictions are loosening. North America is its largest market, accounting for 39% of total sales. The region is seeing a surge in live events after Las Vegas reopened without restrictions in June 2021. As a result, net sales in the region are up 12.3% in the first half (H1) of 2021.

Key financials

Diageo focuses on acquiring small and big global alcohol manufacturers/brands. I think cash in hand is a crucial factor that determines its expansion potential. In H1 of 2021, net cash from operating activities was up £0.7bn, rising to £2.0bn. The free cash flow increased to £1.8bn from £0.8bn. These are encouraging signs for Diageo shares in 2021 and beyond.

The increase in cash reserves stems from lower tax payments in 2020, combined with reduced creditor balances with improving sales. The company also resumed the return of capital (ROC) programme of up to £4.5bn to shareholders. As a result, the interim dividend increased 2% to 27.96 pence per share.

The focus on markets like China and India is excellent news with the region accounting for 20% of total sales. Greater China net sales increased 15% in H1 of 2021. Diageo India (a subsidiary of Diageo PLC) reported a net sales increase of 57% from 2020 levels. Improved sales in these large alcohol markets is a positive sign for Diageo shares.  

The company is predicting a 14% increase in organic revenue in 2021 with CEO Ivan Menezes saying that business is recovering well post-pandemic.

Concerns

Earnings per share has decreased 14.6% to 67.6p as a result of a 3.4% drop in organic operating profits and unfavourable exchange rates in international markets in 2020. At the current trading price the price-to-earnings ratio stands at 32, which looks to me like a classic case of inflated valuation.

The focus on international markets opens the company up to uncertainty with tight regulations in the industry. Though the company owns major international staples like Smirnoff and Johnnie Walker, local prices and profits are subject to constant change.

But I still remain optimistic about the future potential of Diageo shares and it remains on my list of FTSE 100 shares to buy for long-term returns.

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Suraj Radhakrishnan has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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