Diageo's share price has increased by more than 300% since the financial crisis of 2009. In this article, I argue that the share price is somewhat stretched and that expected returns are not particularly attractive. I also calculate a target price at which I would be happy to invest.
Diageo is a well-known and generally much-liked business. It develops and manufactures alcoholic drinks such as Smirnoff, Guinness and Johnnie Walker, which it then sells into more than 180 countries.
Diageo is a member of the FTSE 100 and has an enterprise value (i.e., the market value of shareholder equity plus debt) of around £87 billion, so it's a very large and high-profile company.
Emerging market expansion and developed market premiumisation
Diageo's strategy for growth is to take advantage of two long-term trends:
- Emerging market expansion and
- Premiumisation of alcoholic drinks in developed markets
Emerging market expansion: As emerging markets grow, their populations will usually have more disposable income. That income allows them to either a) buy alcoholic drinks they couldn't previously afford, b) buy legal drinks rather than black market drinks and c) buy more expensive and "aspirational" international brands rather than cheaper local brands.
Diageo expects an additional 750 million consumers to be able to afford international brand spirits by 2030, which is a lot by any sensible definition.
Diageo tries to increase the amount and quality of alcohol drunk in these countries by offering a mix of both international and local brands at a variety of price points. The company's long-term goal is to help these markets go through the same process of drink premiumisation as is currently occurring in developed markets.
Developed market premiumisation: In the US, many beer drinkers are upgrading to premium "craft" beers or switching to more expensive spirits. In Europe, spirits are replacing wine as the drink
