Diageo: Has the Share Price Reached the Bottom?
Diageo: Has the Share Price Reached the Bottom?
In this week’s report, we revisit Diageo, evaluating its performance over the past year and exploring recent developments, including challenges in Latin America and changes in consumer sentiment. These factors have contributed to missed guidance and a significant decline in Diageo’s stock price. We also compare its performance to industry peers and conclude with a valuation update.
Brief Overview:
Overview: Diageo plc (ticker: DGE) is a global leader in the production, marketing, and sale of alcoholic and non-alcoholic beverages. The company’s portfolio exceeds 200 brands, including Johnnie Walker (Scotch whisky), Smirnoff (vodka), and Guinness (beer). Operating in over 180 countries, North America accounts for approximately 39% of Diageo's net revenues. Scotch remains the company’s leading spirit, comprising about 24% of sales, while Tequila, the fastest-growing segment, now represents around 11% of sales, up from just 1% in FY16.
Key Investment thesis: The market seems to be overreacting to the short-term challenges facing the alcoholic beverage industry, resulting in historically low valuation multiples for companies like Diageo. The current market sentiment appears to be driven by concerns over potential structural headwinds, such as shifting consumption patterns among younger generations and the impact of drugs like Ozempic, which reduce alcohol cravings. Additionally, the industry's post-COVID-19 recovery challenges have negatively compounded the market’s reaction. However, the underlying fundamentals remain strong: demographic trends, rising incomes in developing markets, spirits gaining share in Total Beverage Alcohol (TBA), and long-term premiumization trends are all powerful drivers of future growth.
Diageo’s strong market position, supported by leading brands, positions it well to capitalize on growth opportunities in key regions such as India, China, and Latin America.
Contents:
Performance Update
Industry
Valuation
Conclusion
1. Performance update
Diageo reported results for the fiscal year 2024 on July 30th with the stock price falling approximately 6% at market open. Year-to-date, the stock is down 17%, and it has declined 29% since our initial coverage (article: Diageo - A Taste of Success in the Beverage Industry).
a. Missed Guidance and Lowered Profitability Targets
How Has the Story Evolved Since the End of FY23?
In FY23, Diageo achieved organic revenue growth of 6.5% and organic operating profit growth of 7%. Despite organic volume decline of 0.8%, price inflation and the growing popularity of spirits like Scotch and Tequila enabled the Company to meet its mid-term targets (5-7% organic revenue growth and 6-9% organic operating profit growth).
As FY24 began, management initially reaffirmed these mid-term targets, even though organic revenue growth had slowed to low single digits in the second half of FY23. The deceleration was attributed to tough comparisons with the post-pandemic recovery (organic growth in H2'22 was around 22%) and the normalization of inventory levels in Latin America and Caribbean (LAC) following a period of hypergrowth (31.7% CAGR from FY20 to H1’23). Management anticipated a gradual improvement in organic revenue growth during H1’24 relative to H2’23.
But What Really Happened?
Source: Diageo Financial Results, StockOpine analysis | Note: Diageo does not explicitly provide organic sales growth for the second half of the year. The chart reflects our estimate based on the first half and full year organic sales growth
Three months after reaffirming its guidance, management issued a trading update that revised expectations downward. The Company forecasted slower organic growth than in H2'23 and a decline in organic operating profit compared to H1'23. This adjustment was primarily due to weaker than expected performance in LAC, as organic sales were anticipated to decline by 20% in H1'24, driven by macroeconomic challenges, consumer downtrading, reduced consumption, and slower inventory turnover. In hindsight, it appears that retail channels in LAC were overstocked, and Diageo had limited visibility into inventory levels, exacerbating the region's challenges. As a result, H1’24 saw organic revenue decline of 0.6% (with LAC experiencing a -23% organic growth rate) while organic operating profit declined by 5.4%.
Source: Diageo Financial Results, StockOpine analysis
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