Inflation fell to its lowest levels since 2021, but the FTSE 100 also slipped back this week. I’ve been taking the opportunity to add to an investment in my portfolio.
The UK’s largest index fell by 1%, but Diageo (LSE:DGE) shares fell by much more. And I decided to buy the stock as it got close to its 52-week low.
Demand issues
The Diageo share price has fallen from £34.91 to £27.15 over the last 12 months. The biggest reason has been weak demand in Latin America and the Caribbean.
This area accounts for around 10% of the company’s revenues, so it probably doesn’t justify the stock falling 23%. But the risk is that it doesn’t stop there.
Around 37% of Diageo’s sales come from the US, where a number of consumer discretionary businesses have been reporting weak demand. This could be a much bigger danger.
I wouldn’t buy the stock if it was still at the same level it was a year ago. But at today’s prices, I think the investment equation looks different.
Valuation
Diageo currently has a market-cap of £60.25bn. The company has another £21.4bn in debt on its balance sheet, which is partly offset by £1.8bn in cash.
That gives an enterprise value of just under £80bn. And the business generates around £3bn a year in free cash flow, which amounts to a 3.75% annual return.
That’s a bit short of the yield currently offered by a 10-year UK government bond, which is 4.26%. But while Diageo is facing some issues at the moment, it does have scope to grow.
The company’s revenues have grown at 5% a year over the last decade. Even if this falls to 3% a year, the business should generate more cash than a bond over the next 10 years.
Inflation
I see the latest news around inflation as a double boost for the Diageo. First, it means the company’s input costs should start to stabilise, easing the pressure on its margins.
The firm has some extremely strong brands and this gives it some ability to increase prices to offset higher costs. But it can’t do this indefinitely without demand falling away.
The other benefit is an increased chance of interest rates coming down in the near future. This should provide a boost to consumer spending, which is good for the company.
Inflation falling to 2.3% might not be what some analysts had been hoping for. But I think the news is firmly positive for companies like Diageo.
A stock I’ve been buying
After a 23% fall, the Diageo share price doesn’t reflect a particularly optimistic outlook in terms of growth. With the current issues the business is facing, that’s probably no bad thing.
Intrinsically though, the company’s very strong. And it has some durable assets so I think the chances of an investment at today’s prices turning out badly are relatively low.
