4 Reasons To Invest In Diageo Stock

  • An SEC investigation has resulted in 10% being shaved off the stock since mid July which provides investors an opportunity of getting in at cheaper prices.
  • The company is dedicated to keeping innovation elevated. It wants innovation to be 20% of the business in 5 years.
  • The company is investing on a large scale in international markets to secure market share. Expect these markets to become more streamlined going forward.
  • The company has proven that it will raise its dividend robustly when revenues and earnings are increasing. I expect a much higher dividend growth rate in 2016.

Diageo (NYSE:DEO) is a company that has definitely come onto the radar of astute dividend growth investors. The Diageo stock has basically gone nowhere since 2013 and is down 8.55% YTD but the dividend has gone from $2.83 a share in 2013 to $3.34 a share this year (2015) giving the stock a 8.5% (2 year) annual dividend growth rate even though both revenue and net income are down since 2013 (see charts below)

Diageo Revenue chart

DEO revenue chart

Source: Diageo revenue data by amigobulls.com

DEO net income chart

Source: Diageo net income data by amigobulls.com

This company has raised its dividend for the last 15 years and in some of those years the company made double digit dividend increases because of its higher free cash flow. Moreover, this stock is projected to revive earnings growth over the next 12 months as the company recently announced that the fiscal year had started very well with growth levels of about 5%. Therefore if this trend in growth continues, the company should see a boost in earnings which should elevate the share price going forward. Furthermore, the company is guiding to higher margin levels ( from productivity gains) over a three year period.

One of the main reasons the stock is down this year is the company's issue with the securities and exchange commission. The stock is down more than 10% since its July highs because the SEC is investigating whether Diageo shipped excess products to distributors. Diageo follows a 3 tier model in the US where it first ships its product to wholesalers who then ship it on to retailers. I just don't see this investigation gaining serious traction long term. Even if its a slap on the wrists, astute investors are using this recent downturn to buy large positions. Recent management changes in North America also seemed to have an adverse effect on the stock in June/July for no apparent reason. Investors need to look beyond the presented information here and focus on the big picture. This company has the brands (Guinness, Smirnoff, Johnny Walker) which will continue to be in bountiful demand going forward, especially when you consider the emerging middle class in the east

This industry is extremely cyclical and Diageo learned this in the hard way when bringing products to market behind competitors. Customer tastes change quickly and there is no better example than last year, when interest in its Crown Royal whiskey brand came too late in the flavored whiskey trend. This is why innovation is the key and also the reason the company wants new products to become 20% of the business in 5 years. Furthermore, when a liquor company spots a new trend, it is imperative to get to market first. The company did this for example with its Orijin (Fruit drink with 6% alcohol) product launch in Africa and it took off in many markets such as Nigeria. Competitors saw the new trend and acted quickly to try and steal some market share from Diageo, but the bulk of this new market will stay with Diageo because it was first to market.

Diageo has 27% of the global beverage market and no competitor comes close to the number of units shipped annually. Furthermore, recent acquisitions should increase this stake, going forward, apart from also leading to cost reductions. It is in foreign markets (Asia, Africa and South America) where the company is experiencing the fastest growth. It is investing heavily in these regions even though presently they contribute only 29% of company-wide operating profit whilst having 55%+ of the company's employees. The US market, for example, has less than 10% of the company's workforce stationed there but it contributes 45% to total operating profit. Overtime, with the powerful brands this company has on its books, these markets will become more streamlined which will mean fatter profit margins and less employees (less costs) stationed there (similar to the US)

All of the above points will ensure a nice rally in the stock along with healthy dividend growth. An investment of $50,000 in Diageo stock 10 years ago with dividends re-invested would have ballooned to $123k by 2015, giving the investor an annualized return of 9.45%. The company has proven that when free cash flow levels are elevated, it will increase its dividend substantially. Furthermore, its current pay-out ratio is 57 which means there is still room for robust dividend growth. This stock reminds me of Coca Cola (NYSE:KO) and IBM (NYSE:IBM) in that it has struggled over the past few years due to market conditions changing and also huge capex and innovation investment. It may not reward shareholders with huge share buyback programs like the afore mentioned stocks, but its return on equity metric is still quite high at 18%. There is always a lag between investment and results and I think the work the company is doing (especially in international markets) will pay off big time in the next few years. With a current P/E ratio of 18, Diageo stock looks appealing from these levels.

Jack Foley Jack Foley   on Amigobulls :
Author's Disclosures & Disclaimers:
  • I do not hold any positions in the stocks mentioned in this post and don't intend to initiate a position in the next 72 hours
  • I am not an investment advisor, and my opinion should not be treated as investment advice.
  • I am not being compensated for this post (except possibly by Amigobulls).
  • I do not have any business relationship with the companies mentioned in this post.
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