Diageo stock (NYSE:DEO) currently hovers near its 2020 price levels, marking a four-year low. This is striking, as Diageo is widely considered among the highest-quality companies in the U.K. Due to its top position in the alcoholic beverages industry and an impressive 26-year track record of consistent dividend increases, Diageo has long been held in high regard by investors. Yet, the lengthy share price decline has pushed the stock to valuation multiples not seen since 2012. Thus, I am now bullish on the stock.
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What’s Causing Diageo’s Share Price Plunge?
I can list several reasons that are likely behind Diageo’s stock decline. One such example is heightened competition in the alcoholic beverages market. Nonetheless, these factors pale in comparison to the two significant macroeconomic forces driving the stock downward.
The primary reason relates to interest rates. As interest rates increase, fixed-income securities tend to attract investors seeking income. Consequently, there is typically reduced demand for dividend-paying stocks like Diageo, which offer a comparatively higher risk-reward ratio. Diageo, known for consistently increasing its dividends over the past 26 years, has historically been favored by income-focused investors.
However, with rising interest rates, investors have been likely to reevaluate their portfolios and opt for safer alternatives. This explains Diageo’s ever-lasting share price decline.
The second catalyst contributing to the stock’s decline in recent years is the broader UK equities market remaining subdued. Economic uncertainties, including global trade tensions and other factors, such as reduced pension fund involvement, lower appetite for retail investors, and squeezed household budgets, have dampened confidence in consumer spending and formed a bearish sentiment for UK stocks.
While the FTSE100 (the UK stock market index) hit a new all-time high in May, it’s still up just 7.4% in the last five years. For context, the S&P 500 (SPX) and the Nasdaq 100 (NDX) have rallied by roughly 85% and 123% over the same time frame. Clearly, you can see how this sentiment has affected Diageo, a UK-based company.
Diageo’s Strengths Remain Strong, Nonetheless
Despite these challenges, I think the market underestimates Diageo’s strengths, which support the stock’s long-term growth prospects and overall resilience.
A Market-Leading Portfolio
The most significant strength Diageo features is its diversified, market-leading portfolio. Diageo boasts a portfolio of over 200 brands, positioning itself as a market leader in the global alcohol industry. The company’s diverse range of products spans various categories, including spirits, beer, and wine, with notable brands such as Johnnie Walker, Smirnoff, Guinness, and Tanqueray.
Such a vast portfolio diversifies Diageo’s revenue streams and allows it to capture market opportunities across different consumer preferences and trends. Is, for instance, Tequila becoming more popular these days? Great, Diageo has the necessary brands in the space to capitalize on this trend.
Strategic Investments and Partnerships Add Another Layer of Safety
Besides driving growth with its own brands, Diageo has made strategic investments to capture additional growth opportunities beyond its own performance. For instance, the company holds a 34% stake in Moët Hennessy, the renowned wine and spirits division of LVMH Moët Hennessy Louis Vuitton (FR:MC).
Based on LVMH’s latest report, this division posted a near-record operating profit of €2.11 billion in FY2023. This follows a record operating profit of €2.16 billion in FY2022, which itself had significantly increased from €1.86 billion in FY2021. This stake not only exposes Diageo to the lucrative champagne and cognac business but also enables it to benefit directly from a subsidiary of Europe’s most valuable and arguably best-managed company.
Diageo’s Valuation Doesn’t Reflect Its Strengths
Diageo’s strengths, such as those I just mentioned, and various others, like its recession-proof business model, are not adequately reflected in the stock’s current valuation, in my view. At a forward P/E of 15.9x, Diageo stock is the cheapest it has been in about 12 years, excluding the few-day-long flash crash that occurred in March 2020.
With interest rate cuts likely to start taking place in late 2024 to early 2025, it is reasonable to expect that DEO stock will undergo a notable valuation expansion. Combined with its steady organic growth and a 3.2% dividend yield, Diageo’s bullish outlook appears poised to regain momentum.
IS DEO Stock a Buy, According to Analysts?
Wall Street seems to still have mixed feelings about Diageo’s investment case so far. The stock features a Hold consensus rating based on one Buy, two Holds, and one Sell rating assigned in the past three months. Still, at $146.25, the average Diageo stock price target suggests 12.8% upside potential.
The Takeaway
Overall, Diageo’s current stock price seems to present an appealing investment opportunity following its prolonged decline. Its robust portfolio, strategic investments, and favorable industry dynamics remain key strengths, which are illustrated in its 26-year-long dividend growth track record. In the meantime, Diageo’s valuation is hovering at historic lows, which, along with interest rate cuts likely on the horizon, further bolsters the stock’s investment case.
