Should You Buy Diageo Stock At $175?

Diageo’s stock (NYSE: DEO) is down 20% this year, aligning with the 20% fall in the broader S&P 500 index. A high inflationary environment and slowing economic growth will likely affect consumer demand, impacting food and beverage stocks. Diageo’s peer, Anheuser-Busch Inbev stock (NYSE: BUD), has also seen a 21% fall this year. However, DEO stock looks like it has room for growth, in our view.

Diageo recently announced the acquisition of premium cold brew coffee liqueur – Mr Black – funded through the company’s existing cash resources. ^[1] Mr Black is popular in the U.S., and this acquisition will bolster the region’s sales growth. Furthermore, the company should benefit from the strengthening dollar. It reports its numbers in GBP while it generates a third of its sales from the North America region. While GBP has lost around 20% of its value against the USD this year, there is likely to be some relief for the Sterling after the U.K. government decided not to proceed with the abolition of the 45% tax rate on higher income earners. ^[2] Still, the USD will likely remain strong in the near term boding well for Diageo’s revenue growth. Diageo has also expanded its organic operating margins in fiscal 2022 driven by premiumization and improved fixed cost absorption from volume growth. Also, price increases helped negate the impact of cost inflation.

Looking at DEO stock, we estimate Diageo’s valuation to be $201 per share, reflecting an 14% upside from its current market price of $176, implying that there is more room for growth. Our valuation represents a forward P/E ratio of around 25x based on our earnings forecast of $8.20 on a per share and adjusted basis for full-fiscal 2023. This compares with an average of 26x seen over the last two years. That said, investors should take into account the near-term risks. DEO stock faces headwinds from the current weakness in broader markets. The S&P500 is in a bear market territory with rising concerns of a recession, given the high inflation, Fed action, and supply chain disruptions.

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[1] Month-to-date and year-to-date as of 10/5/2022
[2] Cumulative total returns since the end of 2016

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1. Diageo’s Press Release, Sep 29, 2022 [↩]
2. Sterling rebounds on reversal of proposed tax cut, yen weakens, Rae Wee, Reuters, Oct 3, 2022 [↩]