Diageo Stock Increases 55% – What’s Next?

We believe Diageo stock (NYSE: DEO) may be an opportunity worth considering at the present time. DEO stock trades at close to $160 currently and is, in fact, still down 5% since the beginning of 2020 when it traded at around $168. The stock was at at $162 in February 2020 – just before the coronavirus pandemic hit the world – and is currently still 2% below that level as well. DEO stock has recovered over 55% of its value from its March level of $103, compared to the S&P 500 which gained over 70% from its March lows. However, with the lockdowns being gradually lifted and an expected turnaround in business prospects in FY2021, along with the company’s focus on premium brands,  provides DEO stock with a 10% potential upside as it will likely surpass its early-2020 levels. Our conclusion is based on our comparative analysis of Diageo stock performance during the current financial crisis with that during the 2008 recession in our interactive dashboard.

2020 Coronavirus Crisis

Timeline of 2020 Crisis So Far:

• 12/12/2019: Coronavirus cases first reported in China
• 1/31/2020: WHO declares a global health emergency.
• 2/19/2020: Signs of effective containment in China and hopes of monetary easing by major central banks helps S&P 500 reach a record high
• 3/23/2020: S&P 500 drops 34% from the peak level seen on Feb 19, 2020, as COVID-19 cases accelerate outside China. Doesn’t help that oil prices crash in mid-March amid Saudi-led price war
• Since 3/24/2020: S&P 500 recovers 70% from the lows seen on Mar 23, 2020, as the Fed’s multi-billion dollar stimulus package suppresses near-term survival anxiety and infuses liquidity into the system.

In contrast, here is how DEO stock and the broader market fared during the 2007-08 crisis

Timeline of 2007-08 Crisis

• 10/1/2007: Approximate pre-crisis peak in S&P 500 index
• 9/1/2008 – 10/1/2008: Accelerated market decline corresponding to Lehman bankruptcy filing (9/15/08)
• 3/1/2009: Approximate bottoming out of S&P 500 index
• 12/31/2009: Initial recovery to levels before accelerated decline (around 9/1/2008)

DEO and S&P500 Performance Over 2007-08 Financial Crisis

DEO stock declined from levels of about $89 in September 2007 (pre-crisis peak) to levels of $46 in March 2009 (as the markets bottomed out), implying DEO stock lost 48% from its approximate pre-crisis peak. It recovered post the 2008 crisis, to levels of close to $69 in early 2010, rising by 49% between March 2009 and January 2010. In comparison, the S&P 500 Index saw a decline of 51% and recovered 48%.

DEO Fundamentals Over Recent Years

DEO revenues increased from $15.4 billion in FY2016 to $16.6 billion in FY2019. However, revenues dropped in FY2020 to $14.8 billion on the back of the pandemic. Along with higher revenues, margins increased with EPS increasing from $5.27 in FY2016 to $6.72 in FY2019. Earnings more than halved to $3.03 in FY 2020 due to lower revenues and higher operating expenses.

Does DEO Have Sufficient Cash Cushion To Meet Its Obligations Through The Coronavirus Crisis?

DEO’s total debt increased from $15 billion in FY2016 to $21 billion in FY2020, while its total cash went up from $872 million to $906 million over the same period. At the same time, the company’s cash from operations dropped sharply from $3.8 billion to $2.9 billion. Lower cash flow generation and high debt are risks that DEO could face while tiding over the current crisis.

Conclusion

Phases of Covid-19 Crisis:

• Early- to mid-March 2020: Fear of the coronavirus outbreak spreading rapidly translates into reality, with the number of cases accelerating globally
• Late-March 2020 onward: Social distancing measures + lockdowns
• April 2020: Fed stimulus suppresses near-term survival anxiety
• May-June 2020: Recovery of demand, with gradual lifting of lockdowns – no panic anymore despite a steady increase in the number of cases
• Since late 2020: Weak quarterly results, but continued improvement in demand and progress with vaccine development buoy market sentiment

Diageo stock has recouped the losses it suffered last March, and currently trades around its February-2020 level. We believe that the stock is still undervalued and will rise beyond the levels seen in early 2020 with a focus on the sale of premium brands. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia.

Based on Diageo valuation, Trefis has a price estimate of $175 per share for DEO’s stock.

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