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Diageo Plc ADR(DEO-N)

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1 Magnificent Dividend Stock That's Down 25% and Trading at a Once-in-a-Decade Valuation

Motley Fool - Mon Feb 5, 7:30AM CST

Despite growing sales by 40% over the last five years -- further locking in its status as the world's largest spirits company -- Diageo(NYSE: DEO) has seen its share price dip slightly over the same time. Thanks to this divergence between the company's declining share price and its steady business growth, investors may have an opportunity to buy the adult beverage juggernaut at a deep discount.

Diageo stock trades at a valuation it hasn't seen since 2012 (even including the crash in March 2020). Here's why now may be the time to invest in Diageo and its 2.7% dividend yield.

Diageo is building upon its leadership position

Diageo has a 4.7% share of the total beverage alcohol (TBA) market, and is roughly 40% bigger than its next largest peer. It has the No. 1 position internationally in whiskey, scotch, tequila, rum, vodka, and gin. It boasts a portfolio of over 200 beverage brands, including famous global names include Johnnie Walker, Guinness, Smirnoff, Baileys, Captain Morgan, and Tanqueray.

Despite already maintaining a leadership position in the nearly $1 trillion industry, the company's growth story is far from over. Aiming to grow to 6% of the market by 2030, management expects the three following growth levers to propel Diageo's stock to new highs:

  • Growing middle class: The World Bank expects over 470 million people to join the middle class globally by 2032. This burgeoning category is crucial to Diageo's long-term success, creating a pipeline of potential customers with disposable income to use on the company's premium products.
  • Higher spirits penetration rate: Over the past five years, the overall alcohol market has grown by 4% annually but has been outpaced by spirits growth of 6%. This outsize performance extends a decades-long shift that saw spirits' share of the market increase from 29% in 2000 to 42% in 2022, overtaking beer's top spot. With the vast majority of Diageo's portfolio focused on spirits -- outside of a premium beer offering in Guinness and beer sales in Africa -- the company is well-positioned to thrive from this shift.
  • Premiumization of spirits: Thanks partly to the world's steadily growing middle class, many consumers choose to "drink better, not more," as Diageo puts it. With industry experts expecting premium spirits to grow between 8% and 10% annually through 2030 -- compared to just 3% to 4% for the total alcohol market -- Diageo's focus on the higher-end side of things should help it outperform. Generating 63% of its sales from premium and super premium spirits, a figure that has grown from 56% in 2019, the company will undoubtedly welcome this premiumization trend.

Diageo is quickly shifting its portfolio to capitalize on the growth levers listed above, including adding 11 net new super premium and premium brands through mergers and acquisitions (M&A) while disposing of 49 standard and value labels.

Top-tier profitability

Recording a return on invested capital (ROIC) of 13%, Diageo and its Jack Daniels-making peer, Brown-Forman, are the only spirits-focused companies that consistently generate value for shareholders when putting their debt and equity to use.

DEO Return on Invested Capital Chart

DEO Return on Invested Capital data by YCharts

However, while Brown-Forman matches Diageo on this figure, it heavily relies on the Jack Daniels brand, whereas its market-leading peer boasts a more well-rounded portfolio.

In addition to being tied for the highest ROIC among its peers, Diageo maintains the best net profit margin of the group at 20%. Incredibly enough, this impressive margin is 5 percentage points below its pre-pandemic peak, leaving further room for improvement as management hones in on $3.5 billion in cost improvements it wants to make by 2027.

These potential cost improvements, paired with the company's focus on premium (higher-margin) spirits, could be the one-two punch that brings Diageo's net profit margin back to all-time highs.

A once-in-a-decade valuation

Best yet for investors, despite the company's leadership position, its intriguing growth trends, and its top-tier profitability, Diageo appears to be trading at a once-in-a-decade valuation.

DEO PS Ratio Chart

DEO PS Ratio data by YCharts

At its lowest price-to-sales (P/S) ratio since 2012, the company looks to be discounted, with its share price a full one-third lower than its all-time highs. And with its price-to-earnings (P/E) ratio of 18, Diageo is near its decade-long low of 16 -- although its net income margin has yet to return to pre-pandemic levels.

Thanks to this cheap valuation, the premiumization of the company's portfolio, and a healthy 2.7% dividend that management traditionally funds with 50% of its net income, Diageo is (quite literally) a premium business selling at a tremendous price.

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Josh Kohn-Lindquist has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Constellation Brands. The Motley Fool recommends Diageo Plc. The Motley Fool has a disclosure policy.

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