Diageo (DEO)
Guinness, Smirnoff, Jose Cuervo, and Captain Morgan are just a few of the alcoholic beverages that Diageo (DEO) produces. Many people believe that sin stocks, or stocks of companies that produce goods considered by some to be immoral or unethical, are recession-resistant. As an alcoholic beverage producer, Diageo finds itself in that category. Is there money to be made from this beer-brewing, wine-bottling, liquor-distilling corporation?
Diageo’s net profit increased 16% to $1.63 billion in the six months ending December 31st, 2008. At first glance, these numbers make it seem like the company actually is recession-resistant. But, the increase in income can mostly be attributed to a strong U.S. dollar. Although Diageo is based in Europe, the United States is one of the company’s largest markets. Because the company trades its beverages for strong U.S. dollars, it has benefited from exchange rates.
Analysts actually expected much higher results from DEO. The company itself stated that profit from operations was weaker than desired at the end of 2008. CEO Paul Walsh stated that, “the global economic slowdown has affected business in the period, and in November and December this impact was more pronounced.” Diageo cut its growth forecast for full-year operating profit, citing a lack of visibility for the rest of 2009. The report that missed expectations, when combined with an admission of vulnerability to a weakened economy, caused investors to stray away from DEO.
Diageo’s stock has a 52-week range of $40.93-86.19. It most recently traded at $44.18, very close to its 52-week low. While I believe that some drop in share price was necessary to accommodate for weakened macroeconomic conditions, the current price leaves DEO undervalued.
It’s important to note that Diageo maintains a great deal of strength from its top brands. The names are incredibly popular: Smirnoff is the world’s number one vodka, Jose Cuervo is the leading tequila, and Guinness is the top stout. The majority of DEO’s other alcoholic beverages also maintain large market shares. These brands will not suddenly disappear because of slow economic times.
The company’s statistics are also enviable. Diageo bears a large market capitalization of 27.52 billion, pushes out a reliable dividend yielding 3.6%, and most recently generated a free cash flow of $1.24 billion. Add in the fact that the company currently has $3.45 billion in cash, and it’s easy to realize that DEO is a real powerhouse.
My main fear for Diageo is the weakening of the U.S. dollar. Just as DEO benefits from a strong dollar, a weak dollar hurts it. Its sales and large market share in the U.S. would become less valuable if the dollar becomes less valuable. We’re beginning to see a decrease in value of the dollar resulting from a large amount of government spending, a dramatic increase in the printing of money, and shrinking demand for treasuries and debt from foreign countries.
Nevertheless, the U.S. is only one of Diageo’s many markets. The company acts in about 180 countries in North America, Africa, Europe, and Asia. Considering the company’s powerful brands, international diversification, and financial backing makes DEO a great buy at current levels. Diageo is sitting at a relatively cheap price in an industry that does well in harsh economic times, and now is the time to scoop it up.
-Matt Schwartz
College Trillionaire
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I like your thoughts on this stock, though I would check the projections on the growth of the alcoholic beverage industry before buying.
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