Should Investors Take a Sip of Diageo Stock or Stick to Its Products?

Diageo has wonderful brands, but is undergoing some short-term pressure. With a solid yield and some potential tailwinds I see this is a good long-term buy.

James Sullivan
James Sullivan
Aug 31, 2015 at 7:00PM
Consumer Goods

Source: Diageo.

Diageo PLC (NYSE:DEO) is a global consumer-goods giant that produces and distributes a broad array of spirits, wine, and beer. Many of its products are household names around the globe, while others are only popular within particular regions. It has had some troubles over the past few years, and the stock price has reflected these struggles. Shares are down more than 10% over that period, while the overall market has risen.

Yet Diageo has a wonderful stable of brands that it continues to add to, has a solid focus on regional beverage desires, and offers investors a nice yield while they wait for global growth to resume. Let's take a closer look.

Revenues down along with the share price
Diageo was once about as predictable a company as one could ask for in the investing world. By selling alcoholic beverages, where brand loyalty matters a great deal, on a global scale, it was able to grow revenue every year, from 7.26 billion pounds in 2006 to 11.43 billion pounds in 2013. Over that time period, its stock price was up well north of 100%, not including dividends. Considering that this rise coincided with the global recession of 2007-2009, it was a solid return for investors. Since then, revenues dropped to 10.26 billion pounds in 2014 before rising to 10.81 billion pounds in the most recent fiscal year. 

The stock price has taken a hit, and while much of the drop has to do with changing consumer behavior and a slowing global economy, Diageo has also made a PR misstep of its own. The Wall Street Journal recently reported, the Securities and Exchange Commission is looking into whether Diageo was shipping more inventory to distributors than they wanted to goose its numbers. Diageo has yet to be charged with any wrongdoing, but amid otherwise challenging times, this looks bad for the company and shares dropped in the wake of the WSJ report. 

Brands will always matter
I stay invested in Diageo because short-term blips, potential scandals, and managerial missteps will most often be overcome by wonderful brands and business models. The Salad Oil Scandal didn't sink American Express, a victim of that scheme, nor did New Coke do lasting harm to Coca-Cola, and I think we'll look back on this two-year period as a small hiccup on the way to a great growth story for Diageo, which hasn't yet even been formally accused of any wrong doing . 

Diageo's core brands, which it dubs Global Giants, are some of the very best that any company could hope to have in its portfolio. Johnnie Walker, Guinness, and Smirnoff, just to name a few, are category leaders known from London to Los Angeles to Lagos. These brands are the backbone of the company, and while they probably won't exhibit explosive growth, they allow for Diageo to branch out into more regional plays.

Local Stars are the next tier of brands in the portfolio. While they account for only 16% of current sales, I think this share will grow in the future. In North America, Bulleit Bourbon was up 41% in terms of reported net sales movement. In the Asia-Pacific region, Shui Jing Fang was up 245% on the same metric. 

Geographic diversity and knowing how to play it
North America is currently the most important market for Diageo. It contributes 32.2% of total sales and employs less than 10% of the global workforce but is responsible for 45.4% of operating profit. The company notes how wonderful a market this is, and thus competition abounds. Innovation is key to continue to satisfy shifting tastes. The shift from vodka to whiskey, as demonstrated by the explosive growth of Bulleit, was able to be capitalized on because Diageo is constantly seeking out new trends and products to be added to the fold. 

Africa, Latin America, and Asia-Pacific account for 43.4% of net sales but only 29.4% of operating profit. While it's important for Diageo to strengthen its presence in North America, this is where the big growth is to be had. It takes time to establish brands and build relationships with local governments. Over half of Diego's global workforce is in these three regions. This is an expensive presence, but one that I believe will pay off as individual purchasing power improves; transportation becomes easier, thus lowering SG&A expenses; and the company's brands allow it to command premium prices, driving the top-line higher.

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Don't worry about waiting
I'm not sure how long it will take for these investments to bear fruit, but luckily for investors, Diageo pays a healthy dividend. With a current yield above 3% -- 10-year U.S. Treasuries currently yield around 2% -- I'm happy to wait and see what the future holds. The payout ratio of 58% is a little higher than I would like to see, but not alarmingly so. Its forward P/E of just under 17 is lower than the S&P 500s at 18.7, as well as its own five-year average P/E of 19.

This stock will almost certainly not be the best performer in your portfolio, but for those looking for international exposure, a promising growth trajectory, and a healthy dividend payout that should continue to grow, I recommend taking a deeper look at Diageo.