Comment: the growing speculation over Diageo’s stock

What began as a single broker advising clients that Diageo might be a good stock to buy because it looks undervalued, when considering the assets within the business, has developed into growing speculation it could face a takeover bid. Ron Emler investigates.

London stocks are seen as their cheapest since 2018, according to the Financial Times, and are being eyed by overseas financiers but there is no evidence that the speculation could be correct other than a closer look at Diageo’s numbers.

As the world’s major spirits groups readjust to meet the consumer downturn created by inflation, higher interest rates and the swing to beer from spirits, Diageo’s shares have been badly hit.

Third of value

From a heady high of just over £40 each in spring 2022 when the post-Covid recovery boom was in full flood, they have lost more than a third of their value to stand at just under £26 each.

Although the entire beverage alcohol sector has been on a downtrend, much of the slump in Diageo’s shares came immediately after last November’s surprise profits warning.

That was triggered by an abrupt downturn in Latin American and Caribbean trade which left the group with embarrassingly high stock levels, a phenomenon that its previously vaunted data systems failed to pick up.

The shares fell by 12% in a single day when the projected 20% sales slump in a region which accounts for more than a tenth of its business was revealed.

Action plan

Chief executive Debra Crew tried to reassure investors saying: “We have set out a clear action plan to address recent performance challenges in our [Latin America and the Caribbean] region and we remain confident in the long term.”

That suggested that the group would soon be back on the growth path and that the financial damage might be limited to the trading year which ran until the end of last month.

So much attention will be paid to how far Diageo has been able to correct the problem when it releases its annual figures in a couple of weeks’ time.

But the shares have also been under a cloud because rivals such as Brown Forman, Constellation Brands, Remy Cointreau and Moet Hennessy have all recently
reported a difficult North American spirits market. That is Diageo’s single largest source of profits.

The same is true of China, where consumer spending, especially of Western luxury goods is in the doldrums.

Twice value of Tesco

Diageo is valued by the market at about £56 billion, more than twice the value of Tesco.

Predators always need to offer a significant premium to tempt shareholders to sell out but even offering the £88 billion at which the group was valued in 2022 not might be enough to tempt the present investors, more than 40% of whom are US-based.

Diageo is in an elite for increasing its dividend every year this century and is highly prized by longer-term investors for that reliable cash flow.

What is more, with its world leading brands across all categories, it stands to benefit the most when the next spending upturn comes around. That, of course, would be part of its attraction.

The huge sum needed to fund a successful takeover could not come from any of Diageo’s rivals, all of whom are significantly smaller and who anyhow would face competition problems if they wanted to fold global champions such as Johnnie Walker, Baileys, Smirnoff, Tanqueray or Don Julio into their portfolios.

So if, and it is a huge if, the world’s financiers are tempted to launch what would be one of the biggest bids in London stock market history, the only objectives would be either to run Diageo themselves or to sell off key brands which they believe to be worth more separately than together.

Guinness

There are perennial rumours that Diageo might sell off Guinness but management has always rejected that idea. Indeed, the group is building a giant new brewery in Ireland and has consistently pointed to symbiotic sales benefits between the stout and its premium spirits portfolio.

A satisfactory set of results plus an encouraging outlook at the end of the month will be critical to dispelling the rumours.

Meanwhile, assuming the share price starts to recover, brokers tipping Diageo are on an each-way winner of a takeover or a recovery.