Diageo plc: Opportunity Or Threat?

Diageo plc (LON:DGE) is suffering from a brief chill in emerging market spending…

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DiageoDiageo  (LSE: DGE) (NYSE: DEO.US) is in the dumps right now. Partly that’s a result of lacklustre market demand for non-cyclical stocks, and partly it’s down to the company’s poor financial performance. This dichotomy leads to quite a lot of confusion over the outlook for the alcoholic drinks maker. My view is that unless investors are happy to sit on the sidelines for a very long period of time, they should stay well clear as this company has quite a lot of value left to shed.

For a start, despite being 8% lower than its value one year ago, Diageo is trading at a P/E of around 19.5 right now. That’s hardly cheap for a company that shed 8% of its income and an even larger share of its revenue over the last year.

While it’s true that Diageo has a record of returning value to shareholders over the long term, right now the prospects of that term arriving any time soon look remote. In the past quarter, organic sales rose just £3.13 billion, falling short of analysts’ expectations of £3.2 billion growth by some 20%.

Emerging Troubles

Much of this, Diageo executives maintain, is a result of China and other fast-growing Asian markets scaling back on the amount of expensive wine and whisky they consume as their economies cool off. Diageo maintains that its market share is actually rising in these countries, which is probably true, but no less comforting for investors who are expecting the shares to rise any time soon, since Asian emerging economies are not showing signs of quickly rebounding back to the recent go-go years.

In North America, which comprises a third of Diageo’s market share, the company might fare somewhat better now that the economy is on the rebound after a half-decade long slump. But gains on sales in North America are not likely to impact the bottom line any time soon. That’s because profit margins on the £3.44 billion of sales there are considerably lower than on the £1.35 billion of sales the company makes in the Asia-Pacific region.

This is borne out by a closer look at the company’s sales and earnings. In the past year, revenue dipped 9%, more or less matching the 8% loss in the company’s earnings. While Western Europe and the North America sales fell 8% however, in Asia and Latin America sales declined by more than double, 17.5% lower. Combined with the observation that revenue and earnings were well matched at the headline level, it’s easy to see that a dollar earned in the emerging economies counts for much larger slice of the pie than a dollar earned at home.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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