Diageo (LSE: DGE) has been one of the best performing investments in the FTSE 100 this year as the Diageo share price has risen strongly. Year-to-date, the stock has produced a total return of nearly 19%. Moreover, in the past 12 months, it has returned 22%, including dividends.
Shares in the drinks giant fell around a third in the first quarter of 2020, as the coronavirus pandemic spread around the world.
However, since then, the stock has experienced a steady recovery as the fallout has not been as bad as initially expected.
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In fact, sales and profits have recovered so quickly that Diageo said it would resume plans to return £4.5bn to shareholders earlier in the month. It suspended this plan in April last year after returning just £1.3bn through buybacks.
Diageo share price outlook
It seems the market is hoping Diageo’s recovery will continue. I think the chances are it will.
While it’s still early days, initial sales figures from the hospitality industry in the UK show that consumers have been happy to splash the cash as they’ve returned to bars and restaurants. And this trend is echoed around the world.
Diageo’s North American sales grew 12% in the first quarter. The reopening of the US economy powered growth.
But the Diageo share price is far more than a reopening investment. The owner of alcoholic beverage brands such as Guinness and Johnnie Walker is also a play on emerging markets growth.
It owns 50% of India’s largest spirits business and has a foothold in the Chinese market. The growing middle class in these regions could lead to increased demand for Diageo’s higher-value brands.
I believe this potential is the main reason why the stock has performed so well over the past few months. As the global economy starts to move on from the pandemic, Diageo’s global footprint and premium brands may register strong growth.
Risks and challenges
Despite the above strengths and opportunities, Diageo does have its risks. For one, borrowing is a little on the high side.
Net debt was equivalent to 3.4 times cash profits at the end of December 2020. This level of borrowing appears sustainable, but it could be a considerable risk for the enterprise if interest rates rise significantly. The company may have to reduce shareholder returns to free up capital to pay down debt.
At the same time, higher commodity costs could hurt profit margins. This may once again lead to lower shareholder returns.
Still, despite these risks, I’m pretty content to own Diageo and would buy more of the stock for my portfolio today.
I think the company’s portfolio of billion-dollar brands gives it a substantial competitive advantage. Further, its position in emerging markets should enable the group to profit from these regions’ economic growth.
Overall, I reckon the trends that have pushed the Diageo share price higher over the past year may continue.
