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Is Diageo Stock a Buy?

By Anne Burdakin – Apr 10, 2020 at 1:16PM

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Premium brands can make for a resilient business.

While the world medical community works toward containing COVID-19, investors are sifting through stocks, trying to identify the companies that present the opportunity of a lifetime while avoiding those that will struggle to recover from the bear market. Consumer-discretionary stocks in the food and beverage industry have been hit especially hard by the pandemic.

The share price of London-based alcoholic beverage giant Diageo (DEO -1.44%) recently approached five-year lows. Is this one of those golden buying opportunities?

Two women in a bar about to drink shots of premium alcohol.

Image source: Getty Images.

How will premium alcohol brands fare during the downturn?

Founded in 1997, Diageo is a global leader in the alcoholic beverage market with ownership of over 200 brands of beer and spirits. The company's products are sold in more than 180 countries.

Notable brands include Johnnie Walker, Crown Royal, J&B, Buchanan's, and Windsor whiskies; Smirnoff, Ciroc, and Ketel One vodkas; Captain Morgan rum, Baileys Irish Cream liqueur, Don Julio tequila, and Tanqueray gin. Beer, led by Guinness, is the company's second largest category after scotch. 

This broad portfolio appeals to markets in both developed and emerging countries. Management's strategy is focused on accelerating growth of higher-margin premium brands by first participating in the mainstream spirits market, then introducing consumers to more expensive premium and reserve brands through aspirational marketing. 

All of this was working great with consistent revenue growth, a rising share price, and 20 years of dividends -- until the coronavirus outbreak.

With bars, restaurants, and many liquor stores closed, the share price has dropped about 20% year to date, giving the stock a price-to-earnings valuation of 20.

DEO PE Ratio Chart

Data by YCharts.

On April 9, the company provided investors with a business update related to COVID-19. The company said demand was slowly returning in China, but in most other areas of the world, a significant portion of demand has dried up due to widespread restaurant and bar closures. However, management noted that retail sales have seen a boost over the past several weeks, but management is uncertain whether the heightened demand in that channel will last. Given the uncertainty around so many major markets, the company withdrew its guidance for organic net sales growth and organic operating profit growth for fiscal 2020. 

The world will eventually get through this difficult period, and people will again go out to bars and restaurants. Diageo, with its leading portfolio of brands, should slowly return to normal operating conditions. In the meantime, Diageo aims to keep its name in consumers' minds by donating alcohol to hand sanitizer producers worldwide to help address shortages. The contribution will help create more than eight million bottles of the disinfectant. 

Is it time for investors to raise a glass?

As of this writing, Diageo stock offers an attractive dividend yield of 2.1%. The 2019 year-end report noted that the company targets a coverage ratio (earnings per share to dividends per share) of 1.8 to 2.2 times. Dividend coverage for 2019 was 1.9 times, and before the coronavirus, management was planning to make adjustments until that ratio was closer to the midpoint of its target range.

Diageo's underlying fundamentals include massive brand power and global revenue distributed over a wide range of markets. In calendar 2019, sales grew 4.9%, and adjusted earnings per share jumped 7.0%. 

In the April 9 statement, CEO Ivan Menezes reassured investors that the April dividend would be paid, but management suspended its share repurchases through the rest of fiscal 2020. 

All things considered, I think investors should wait to invest until management can provide a more detailed business outlook in light of the pandemic. Diageo's underlying business is solid, but I'd like more clarity on any strategic changes given uncertain market realities. 

Anne Burdakin has no position in any of the stocks mentioned. The Motley Fool recommends Diageo. The Motley Fool has a disclosure policy.

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