In yesterday's e-mail, I took a first look at U.K. spirits conglomerate Diageo (DEO), whose stock is close to a 15-year low.
As I wrote, I was also intrigued about the steps the new CEO is taking to improve the business. Could this be a turnaround story?
To answer that question, let's start by digging into Diageo's financials over the past 20 years and its current valuation...
Thanks to its portfolio of strong global brands – including Johnnie Walker, Crown Royal, J&B, Buchanan's, Smirnoff, Cîroc, Ketel One, Captain Morgan, Baileys, Don Julio, Casamigos, Tanqueray, and Guinness – Diageo has high and stable margins:
It's also consistently profitable, though it has shown little growth in the past two decades:
As you can see above, operating income has declined modestly the past three years.
However, free cash flow ("FCF") has risen slightly over the same period into the $2.5 billion to $2.7 billion range – though this is down from the $3.3 billion average in the three years pre-COVID:
The company has generated substantial FCF, totaling $58 billion over the past two decades.
But over the same time frame, it has spent $73 billion: $11 billion on acquisitions, $22 billion on share repurchases, and $40 billion on dividends:
Not surprisingly, therefore, the company's net debt has risen by $15 billion over the past two decades:
The $22 billion spent on share repurchases has reduced the number of diluted shares outstanding by 22% – a bit more than 1% per year on average:
Overall, the financials tell a mixed story...
Diageo has wonderful global brands that support high margins and steady FCF. But it has struggled to grow, its capital allocation hasn't created much value, and net debt has risen to $22.1 billion. That's not a dangerous level, but it's high enough that the company has stopped repurchasing shares the past two years and also slashed its dividend in February.
But these issues appear to be reflected in the valuation. At yesterday's closing price of $82.16, the stock is trading at a mere 12.7 times this year's earnings estimates of $6.48 per share – slightly down from last year's $6.55.
This valuation is only a bit more than half of the price-to-earnings multiple of the S&P 500 Index.
And it's even less than the 13.5 times forward multiple that fellow spirits maker Brown-Forman (BF-B) reached last month when its stock hit a 15-year low. (As I've discussed in recent e-mails, two potential acquirers have emerged since then, pushing the stock up 28%.)
The entire spirits industry is weak for a variety of reasons: the emergence of new brands, marketing via the Internet and social media, less drinking by young people, and the possible impact from millions of people on the GLP-1 weight-loss drugs.
But I think many of Diageo's problems are self-inflicted. With such high margins and cash flows, it's easy to see how complacency could have set in.
This is why I think it's good news that Dave Lewis took the helm at the beginning of this year. He got the nickname "Drastic Dave" for his decisive leadership style, honed over 30 years at consumer-goods giant Unilever (UL) and six years as CEO of grocery retailer Tesco. He appears to be just what Diageo needs.
In only four months, he has already reset expectations, slashed the dividend to start reducing debt, improved internal systems, and sold noncore assets.
My Stansberry's Investment Advisory team and I are going to do a deep dive on Diageo. If we think it's time to buy, as always, subscribers will be the first to know. You can become one by clicking here.
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.