Is this Discounted Stock Too Good to Ignore?

THE VALUE INVESTOR: Best-in-class scale and brand loyalty make Diageo a stand-out consumer staples name now that it's shaking off the hangover from some ill-timed decisions

Philip Gorham 4 August, 2015 | 4:12PM
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We think Diageo (DGE) has significant ability to continue to stave off competition, causing us to issue the shares with an economic moat rating of ‘wide’. Diageo is importance as a vendor to both on- and off-channel customers as a result of its broad product portfolios in large areas of distilled spirits, and we think it will benefit from the long-term trend of of building premium brands within alcoholic beverages. 

Although we would prefer to buy the stock at a wider margin of safety, we believe the 14% upside to our fair value estimate, which values Diageo at 19 times fiscal 2016 earnings, offers investors an opportunity to kick the tyres of this high-quality name.

The punches keep coming for Diageo. In the heady days before the financial crisis, Diageo enjoyed some of the strongest pricing power in consumer staples as drinkers paid a premium to trade up to distilled spirits. When the crisis hit, however, and with the multi-year premiumisation trend in reverse, Diageo had few levers to pull, having raised prices too high too quickly in the boom years. The hangover cure of lower pricing and slower organic growth has taken three years to take effect, and although Diageo is still struggling to reignite volume, last year was the first year it achieved real pricing in several years.

At the same time that it wrestled with the excesses of the past, Diageo entered into some badly timed and poorly executed acquisitions. The firm acquired a stake in baijiu producer Shui Jing Fang for almost 4 times sales in 2011, just before the Chinese government cracked down on conspicuous consumption. Earlier this year, Diageo increased its investment in India's United Spirits to 55%, only to discover almost £150 million in loans made by the firm to its previous owner for capital needed elsewhere in his business empire. Finally, it was revealed last month that the Securities and Exchange Commission was looking into channel stuffing by Diageo in the US.

Despite all these punches, we think the valuation discount looks very compelling for an investor seeking exposure to this sector.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Diageo PLC2,836.50 GBX0.48Rating

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Philip Gorham  

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