Beer, wine & spirits stocks have been out of favor during the bull market over the past couple of years. I attribute this to factors that include changing attitudes towards alcohol consumption and the return to onsite work post-pandemic. The latter has left alcohol producers with excess inventory that has hurt their turnover ratios.
Stay Ahead of the Market:
- Discover outperforming stocks and invest smarter with Top Smart Score Stocks
- Filter, analyze, and streamline your search for investment opportunities using Tipranks' Stock Screener
There have been some modest signs of improvement for the industry, and not long after I put several alcohol companies on my watchlist, the U.S. Surgeon General issued a warning about a link between alcohol consumption and cancer risks, with investors speculating about new safety labeling requirements on alcohol products. On top of what appears to have been some tax-loss selling, the Surgeon General warning has driven some major tickers back towards their 52-week lows, including Diageo PLC (DEO). Personally, I think it’s time to start nibbling in the sector.
Today I’m analyzing British alcohol giant Diageo, which specializes in spirits but does have some beer and wine exposure. Shares of DEO are down more than 30% in the past two years, and nearly 50% since their all-time high reached in late 2021. I’m bullish on DEO stock, though with a contrarian viewpoint.
Diageo Background
I view Diageo as the second-largest alcoholic drinks company in the world, behind Anheuser-Busch InBev (BUD). Unlike BUD, which is primarily a beer company, Diageo focuses mostly on spirits and operates some of the best known brands in the world, including Johnny Walker, Crown Royal, Smirnoff, Captain Morgan, Seagram and others.
I don’t think it’s a stretch to suggest that when most consumers are browsing the aisle of their local liquor store they don’t realize that most of the brands belong to just a few companies. Diageo’s management sees a long-term consumer trend away from beer and wine towards spirits, which I agree with and is one of the reasons I favor DEO stock today, though BUD stock is also at a multi-year low currently.
Surprisingly, Diageo was only incorporated in 1997, although most of its brands, including Guinness on the beer side, are much much older than that. Interestingly, although the company is headquartered in London and has most production infrastructure in Europe, Asia-Pacific, and Latin America, its top sales market is North America at 39%. It’s important to realize that on a volume basis, North America represents only about one-fifth of sales due to lower pricing in other markets around the world. But when it comes to financial results, the U.S. and Canada are the juggernaut.
Diageo splits its product into five categories, from “Luxury” to “Value,” and the below chart illustrates the breakdown based on fiscal 2023.
Diageo’s Financials
Alcohol companies that focus on spirits tend to operate with higher margins than those that focus on beer and wine. Of the peers I’ve evaluated, Diageo stands with the highest gross margins slightly above 60%, although its close peers including Brown Forman ($BF.B) have margins very close to that level. In comparison, BUD’s gross margins are in the mid-50% range while Molson Coors’ (TAP) margins have recently dropped below 40% given their focus on the low end market.
While sales growth has not only slumped, but turned negative, investors can take comfort in Diageo’s very steady margin profile. There’s very little volatility, and that’s especially impressive given how geographically diverse the company is. Diageo management does engage in currency hedging.
One of the items that has hurt net profit margins has been increased interest expense on the company’s debt. In US dollar terms, interest costs rose nearly 15% for the Fiscal year ending June 2024. That’s crimped earnings along with sales that have stuttered. Adjusted earnings per share (EPS) fell from $1.96 to $1.73 for Fiscal 2024, which represents a price-earnings (P/E) ratio of about 17.5 times versus the Diageo’s UK trading price of about 2450 pence. (It’s important to understand that the Diageo’s ADRs (American Depository Receipts) which trade on the NYSE represent four shares each).
Diageo’s Outlook
While DEO stock trades basically in line with its spirits-focused peers, I prefer it for its defensive qualities. This is a company with many of the most recognized alcohol brands. I want to invest in the best and biggest, and I appreciate the company’s diversified geographic exposure. The company seems to have made some headway with inventories, and that’s helped Operating Cash Flow rebound from a seven-year low in Fiscal 2023.
As for the U.S. Surgeon General’s warning about alcohol, I don’t believe it will make a serious dent on the industry. While there have been similar cautionary reports released in Canada and elsewhere, most public reactions have been of disbelief, and I’ve seen very little evidence of people rethinking their alcohol consumption. I think investors can also take a cue from the tobacco industry, whose biggest companies continue to realize growing revenues.
As mentioned earlier, I do like Diageo’s focus on spirits, which I believe offers better prospects than beer or wine. Spirits are certainly less susceptible to microbreweries than beer. Diageo is well positioned from this perspective. One risk to keep an eye on is the possible implementation of trade tariffs, given Diageo’s very international manufacturing footprint. However, lobbyists are already rallying against the idea of any potential U.S. tariffs on alcohol, and I agree that the public uproar over higher alcohol prices would be very difficult for the Trump administration to ignore.
How Does Wall Street View DEO Stock?
With Diageo being a U.K. company, only one analyst covers the NYSE-listed ADR. Looking at the London-listing (GB:DGE), six analysts cover the company. Among those, there are four Buy ratings, one Hold rating, and one Sell rating. The average GB.DGE stock price target is 2816 pence, which translates to a price of about $140.05 based on the recent GBP/USD exchange rate. That’s about 15% higher than the recent trading price of around $121.50.
Conclusion
After years of underperformance, Diageo, along with many of its peers, appears to be on the recovery track. That recovery was stunted by the U.S. Surgeon General’s recent warning on alcohol, bringing DEO stock back towards its 52-week low. Diageo owns some of the most recognized brands in the alcohol industry, has terrific diversification, and defensive qualities. This is a company that I wager should mount some recovery in 2025. Meanwhile, the stock pays a 3.5% dividend yield.
