Want to live longer? Try a stiff drink. A recent study from the University of Texas at Austin suggests that abstaining from alcohol can actually increase your risk of dying younger. Researchers found that, compared with heavy or moderate alcohol drinkers, teetotalers have the highest mortality rates.
What does the discerning investor do with this information? Well, after pouring yourself a drink or three, you might consider buying a few shares of Diageo (NYSE: DEO), the world's largest producer of premium spirits.
Why you might consider having a drink
Diageo is the powerhouse behind names such as Johnnie Walker, Guinness, Baileys, and Smirnoff. Its brand list is unmatched, including 17 of the top 100 premium distilled spirit brands worldwide. Diageo's "premiumisation" strategy moves customers up from lower- to higher-priced brands. This trading-up phenomenon can be seen in products like Johnnie Walker, which comes in the run-of-the-mill Red Label, the somewhat-fancier Black Label, and the uber-premium Blue Label.
Diageo's major global competitors are Pernod Ricard, Bacardi, Fortune Brands (NYSE: FO), and Brown-Forman (NYSE: BF-B). But with net sales totaling around 30% of the premium international spirits industry, Diageo and its worldwide distribution channel sit comfortably atop the competition.
Diageo has strong fundamentals backing its stock. Revenue, earnings, and cash flow have all grown fairly consistently over the past five years at 4% to 8% annually. The dividend yield is more than 3%, and the payout ratio is a comfortable 60%. Over the past five years, Diageo has grown its dividend by more than 5% annually.
Currently, 70% of Diageo's operating profits come from sales to Europe and North America, but its real growth story lies in the emerging markets of Latin America and Africa. With market shares of 26% in Latin America and 39% in Africa, Diageo holds the top position, and there is still plenty of room to grow. These regions offer higher growth rates in per-capita gross domestic product than Europe and the U.S., and most importantly will bring massive growth in a key demographic over the next 10 years: the legal purchasing age population.
Think before you drink
Not everything has gone Diageo's way lately. Sales in Diageo's developed markets of North America and Europe were down for the fiscal year that ended June 30, compared with results from the previous year. The company is expanding internationally but needs to ensure it can keep its competitive advantage at home. Fortunately, Diageo's marketing team is world-class and is doubling down on efforts to increase sales in the principal markets. Consumer campaigns and ready-to-serve drinks targeting the shift to at-home consumption caused by the economic crisis are at the forefront of the strategy to get revenue numbers in the black.
Though Diageo plays in a recession-resistant industry, it is not immune to the tax man; it pays excise taxes of almost 25% of its revenue. Any changes in the economic climate in Great Britain or the U.S., or regulation and excise tax increases, could have a negative effect on its bottom line.
In addition, Diageo's balance sheet may give you some pause. Over the past five years, its debt has risen from 51% of capital to 66%. Sometimes, this can be a sign of long-term problems in the form of diminished profitability and reduced business flexibility. However, there are strong signs that Diageo is simply taking advantage of historically low interest rates to finance the expansion of its product line. Diageo acquired Ketel One a few years back, and there are rumors it may increase its 33% ownership stake in Moet Hennessy. Diageo's cash flow remains strong, so although the debt represents a potential risk, the company has an ample cushion.
If you can get in at the right price, I believe Diageo is a long-term buy and hold. Once you do, those Tanqueray and tonics will taste that much better.
Editor’s note: A previous version of this article made it unclear whether Diageo benefited from TARP funds. Diageo has not accepted TARP funds, and the Fool regrets the confusion.
