Diageo (NYSE:DEO): A Recession-Proof Stock Built for Dividend Growth

London-based Diageo (NYSE:DEO) is a resilient force in the alcoholic drinks industry, recognized for its recession-proof traits. With renowned brands like Johnnie Walker, Smirnoff, and Guinness, Diageo has consistently proven its ability to generate strong financials, even in the toughest economic climates. Its impressive 25-year dividend growth track record is a testament to that. Given the recent dip in its shares, dividend growth investors may find Diageo to be an enticing opportunity. Thus, I’m bullish on DEO stock.

Why is Diageo Stock Recession Proof?

Diageo has developed a reputation for its resilience even in economic downturns, owing to the distinctive dynamics of the alcoholic beverages industry. In times of financial constraint, consumer spending typically contracts. Yet, historical data indicates that demand for alcoholic beverages remains relatively stable even in recessions, as people may turn to these products for comfort or as a form of affordable indulgence.

Moreover, the industry’s adaptability to evolving consumer preferences and market conditions also contributes significantly to the company’s recession-resistant nature. Diageo’s diverse portfolio includes both premium and budget-friendly options, positioning it adeptly to cater to a wide scope of consumers. This diversity ensures that, even in the face of temporary budgetary constraints, there is always a Diageo brand within reach for consumers.

Evidently, Diageo’s financial prowess shone, even in the face of the daunting Great Financial Crisis of 2007-08. Specifically, revenues surged from £7.26 billion in 2006 to an impressive £9.94 billion in 2010. Remarkably, this growth trajectory persisted every year during this challenging period.

Further, during the COVID-19 pandemic, which posed significant obstacles to bars and restaurants, including prolonged closures, Diageo demonstrated exceptional resilience. Despite the numerous challenges faced by bars and restaurants at the time, including prolonged closures, Diageo’s performance remained robust. In 2020, during such an unprecedented industry upheaval, the company experienced only a modest 8.7% decline in revenues, which landed at £11.8 billion.

Fast forward to the close of Diageo’s fiscal year in June 2023, and the company’s revenues had already skyrocketed to an astounding £17.1 billion. This underscores Diageo’s remarkable ability to weather and thrive during periods of elevated inflation as well — a testament to the highly inelastic nature of its business model.

Consistent Earnings Growth Supports a Growing Dividend

Diageo’s consistent earnings growth over the years has allowed the company to grow its dividend for 25 years straight. For context, over the past decade, the company’s earnings per share (EPS) and dividends per share have both grown at a compound rate of 5.4%. While this may not sound like the most impressive growth metric in the world, it’s the consistency that matters.

Diageo’s robust performance was sustained during its Fiscal 2023, which ended this past June. Diageo achieved a substantial 11% growth in net sales, reaching £17.1 billion, with organic growth accounting for an impressive 6%. Notably, earnings per share surged by a remarkable 18% to about £1.65. Even when excluding certain one-off items that boosted this result, EPS still grew by a noteworthy 8%. Further, the company grew its dividend once again, this time by 5% to £0.80.

Regarding Diageo’s future, management mentioned that they are confident Diageo remains well-positioned to deliver strong results over the medium term. Specifically, they expect organic net sales growth in the range of 5% to 7% and durable organic operating profit growth of 6% to 9% in the coming years. Accordingly, it’s reasonable to expect dividend hikes in the mid-single digits, moving forward.

Valuation May Seem Pricy, but Industry Standards Support It

Diageo’s valuation may seem pricy at first glance. The stock is currently trading at around 18x the company’s forward earnings. However, in the context of industry standards, this is not a high multiple for the stock. Generally, companies in the alcoholic beverages industry tend to trade at premium valuations due to their tremendous brand values.

For instance, Dwayne “The Rock” Johnson’s Tequila Teremana hit a remarkable $3.5 billion valuation last year despite only selling 600,000 bottles in 2021. Yes, its rapid growth and The Rock’s involvement contribute to its premium status. Still, it highlights just how common such high valuations are in the industry.

Further, Diageo’s valuation is currently around its lowest level of the past decade. For much of this period, the stock used to trade at forward P/E north of 22x. For context, Diageo’s close industry peers Constellation Brands (NYSE:STZ) and Mexico-based Becle Sabtrades (OTC:BCCLF) are currently trading at forward P/Es of 20.3x and 23.2x, respectively, further underscoring Diageo’s modest discount in the industry.

IS DEO Stock a Buy, According to Analysts?

Turning to Wall Street, Diageo has a Hold consensus rating based on one Buy, one Hold, and one Sell assigned in the past three months. The average Diageo stock price target of $160.67 suggests 5.9% upside potential.

The Takeaway

Diageo stands as a resilient powerhouse in the alcoholic drinks industry, weathering economic storms with impressive financial strength. Its diversified portfolio, spanning premium and budget-friendly options, uniquely positions the company to cater to a broad consumer base, contributing to its recession-resistant nature. Its historical performance, notably during the Great Financial Crisis and the challenges posed by the COVID-19 pandemic, showcases Diageo’s ability to not only endure but thrive.

With consistent earnings growth and a 25-year dividend track record, the stock, though seemingly pricy in valuation, trades at a lower valuation than some of its key competitors. In fact, given its modest discount, Diageo could present an enticing opportunity for dividend growth investors.

Disclosure