🍺Diageo at a 10-year low! Deep value or dead money?

Is Diageo a buy? Or should you avoid it? We give you our thoughts, what our analysts will do with Diageo, and give you the reason(s) why the stock is dropping.

Diageo, established in 1997 through the merger of Guinness and Grand Metropolitan, has ascended to become the world’s largest spirits producer. Renowned brands like Johnnie Walker, Captain Morgan, Smirnoff, and Casamigos showcase Diageo's prowess in creating premium alcoholic beverages. They have an extensive portfolio of over 200 brands.

The current CEO is Debra Crew. Before joining Diageo, she worked at Mars, Kraft Foods, Nestlé, PepsiCo and Mondelez. A few days ago, Nicolai Tangen talked to Debra Crew and discussed the shifting landscape, emerging trends, and other useful insights! Highly recommend for those invested in Diageo or interested in the company or industry.

There are quite a few similarities with The Coca-Cola Company, but the fact that Diageo operates in alcoholic beverages rather than in soft drinks, makes a world of difference. Diageo has advantages of scale and distribution, has strong brands, is the market leader, and has similar margins to other large beverage players.

It is fair to say that Diageo is an empire of great brands with heritage and brand power that are extremely difficult to replicate. Also, Diageo leverages its existing distribution chain to help acquired companies grow and quickly realize cost benefits.

But it’s not all good news. On Wednesday, March 26th, Diageo hit a 10-year low. This means that if you bought Diageo back in April 12th 2013, and held the company for over 10 years, you’d have gained nothing aside from dividends. This is not better than the risk-free rate of roughly 3-4%.

Why is the stock price dropping?

Like always, there is not a single reason, but an accumulation of things happening simultaneously.

1. A decline in sales in Latin America and the Caribbean
   Sales in Latin America and the Caribbean declined by over 20%, thanks to inflation, poor inventory management, and consumers trading down to cheaper booze. It triggered a profit warning back in late 2023, and the pain hasn’t stopped.

   

2. The threat of tariffs
   US President Donald Trump has threatened a 200% tariff on any alcohol coming to the US from the European Union (EU) in the latest twist of an escalating trade war. That’s a nightmare for Diageo, which relies on the U.S. for nearly 40% of its sales. They’re already warning it could shave off $200 million in profits.

   

3. Gen Z makes different choises
   Gen Z is drinking less, and when they do, they often go for non-alcoholic or cheaper drinks. Younger generations are much more interested in living healthy lifestyles than generations past. A good trend for society as a whole, but not so good for shareholders of Diageo or Pernod Ricard.

   

4. Diageo is leveraged
   After taking on significant debt during the pandemic, Diageo’s leverage has climbed to 3.3x net debt-to-EBITDA, above our preferred threshold of 3x. Rather than prioritizing debt reduction, the company has continued buying back shares and paying dividends, raising questions about its capital allocation strategy. Today, Diageo carries nearly $20 billion in long-term debt, including lease obligations. And with free cash flow on the decline, paying that down is only becoming more challenging.

5. The result: low expectations
   Earnings per share dropped from $1.96 to $1.62, and investors are losing confidence. The stock has halved since its 2022 peak, and it no longer commands the rich valuation it once did. EV/EBIT now stands at the lowest point since 2016.

In short: slowing sales, tariff threats, changing drinking habits, and some questionable financial priorities have all shaken investor faith. Our analyst Mathijs wrote a sneak-peek on Diageo back in June 2024 for those interested. We also have a full fundamental analysis for our TDI-members.

Diageo - Premium Research Report - Sneak Peek

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What are our TDI-analysts doing with Diageo?

In Q4 2024, both Mathijs and Luuk initiated a position in Diageo, following a 32% drop from its peak. In hindsight, waiting might have been wiser, since the stock has now fallen nearly 50% from its highs. But a falling share price doesn’t automatically make it a bad investment, or signal a flawed business. If the fundamentals remain solid and their thesis is still intact, then the opportunity has simply become more attractive. Siem and Bouke do not own Diageo and do not intend to start a position. They see too many headwinds and think there are better risk-reward opportunities out there. (We rarely all agree on a single company. Diageo is no exception).

Here’s what our analyst Mathijs, as a Diageo shareholder, says about his investment:

My thesis from April 2024 was based on the following pillars.

1. Diageo is the absolute ruler in spirits, being either the largest or second-largest player based on market share. This offers great distribution and scale advantages. Diageo is bigger than its closest two competitors.

2. Many of Diageo’s brands have pricing power; Johnnie Walker, Guinness, Baileys etc. The brands have great heritage and are protected by complex processes and production locations. For example: it takes 12 years to distill Johnnie Walker Black Label.

3. Although alcohol consumption as a whole might be declining, the spirits and seltzer industry is actually increasing, taking market share from beer and wine drinkers.

I’m going to hold my position in Diageo. I stole Guy Spier’s idea of not selling a company within two years. This makes you learn from eventual mistakes and lets you think twice before buying a new company. Fundamentally, nothing has really changed for me, looking at the pillars described above. If you look at the whole alcohol segment, even the whole luxury segment (except Ferrari and Hermes), every company faces (temporary) headwinds from the industry.

However, something I might have overlooked is the limited quality of the management’s capital allocation. Debt levels are on the high side and might impose a problem if Diageo faces a few difficult years full of tariffs.

If Diageo keeps increasing dividends while increasing their debt position at the same time, I would definitely sell after those two years. If it turns out that the spirits market structurally declines for some reason, that would also be a reason for me to sell because my thesis was also based on an expected 6% yearly revenue growth in the coming five years. I trust in the strength of Diageo and its brands to survive and become stronger. Johnnie Walker was founded in 1820, Guinness in 1759, and Smirnoff in 1864. They faced tougher times than the present, in my humble opinion.

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Our analyst Luuk, who bought Diageo after the analysis back in Q4 2024, recently sold his entire position in Diageo, just a few months later. This is what he said about his decision to sell.

The risk-reward ratio looked interesting for Diageo: not much growth needed, a nice dividend, and an enormous moat.

But when I reflected on my thought process, I realized I hadn’t been critical enough. Even “just” a 3% growth rate isn’t guaranteed when the long-term trends aren’t in Diageo’s favor. With that kind of growth, a P/E of 16 can still be expensive.

What really made me uncomfortable, was the fact that management was borrowing money to pay dividends. That didn’t sit right with me. I felt the right thing to do was to admit my mistakes and sell my position in Diageo.

While I didn’t suffer much financial damage, the lesson is carved into my memory: Focus on companies riding long-term growth trends, and don’t compromise too much just because a stock looks cheap.

What are your thoughts? Does Diageo have the potential to bounce back? Or is it a value trap? In the end, either Mathijs will be right for holding on to the company, or Luuk was right to sell.

If Mathijs decides to sell his shares, our TDI members will be updated in the monthly newsletter.

Have a wonderful day.

The Dutch Investors