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I FTSE 100 the stock I'm looking at is now down 40% since hitting record highs in early 2022.
The company is a beverage giant Diageo (LSE: DGE). The £50bn company has products including Johnny Walker, Guinness again Smirnoffand many premium whiskey and tequila brands.
Drinkers doubled during the violence and spent more money on alcoholic beverages. Diageo has reported record profits for its 2022/23 financial year.
However, the party has come to an end. Long-time shareholders were left with a severe hangover. Diageo's share price has fallen from a high of £41 in 2022 to a low of £25, at the time of writing.
Reducing alcohol
After three years of high inflation, strapped consumers are buying fewer bottles of spirits and choosing cheaper brands.
Diageo's results for the year to 30 June showed a 4% drop in volumes on the previous year. Within this, sales of its value models increased by 5.4%, while sales of its premium models fell by 6.7%.
The worst fall was seen in the Latin American and Caribbean region, where falling stocks prompted a profit warning last year. Another potential risk is the US market, where there are growing signs of a consumer slowdown.
Why I think Diageo can be cheap
Diageo has a broad portfolio of products and is able to adapt to changing consumer preferences. I think spending will recover, over time. Indeed, as a long-term investor, I think the current weakness may be a buying opportunity.
Companies with Diageo's quality metrics are generally more expensive. Last year's results showed an operating profit of 29% and a return on capital employed of just under 17%.
These above-average numbers highlight the company's ability to generate shareholder value, while still investing in growth.
In my opinion, Diageo's strong profitability is perhaps the main reason why the stock has beaten the FTSE 100 over the past 10 years, in spite of the share price has fallen over the past 18 months.
Looking ahead, Diageo shares trade at a 24/25 price-to-earnings (P/E) ratio of 16 with a dividend yield of 3.4%. That's a bit expensive for a business of this type, in my experience.
What could go wrong?
Diageo reported total debt three times EBITDA (earnings ratio) at the end of June. That's a little out of my comfort zone. I would like to see a ratio between 2x and 2.5x. However, it wouldn't stop me from investing, given Diageo's high profit margins.
Another risk I see is that recovery may take longer than expected. This may carry an opportunity cost – maybe I could make more money by investing elsewhere?
What I do
I think Diageo is likely to remain a high quality business with strong products and good financial performance. At current levels, the shares look good value to me and a 3.4% dividend yield is within my buy range for this type of business.
I haven't made a final decision. But Diageo is certainly on my short list to consider as a potential addition to my long-term income portfolio.
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