This article was taken from the August 2024 issue of Market Insight. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications.
Britain has long since been known for its drinking culture: alcohol has been a way to celebrate, socialise, and unwind for centuries. For many of us, a rare sunny day is synonymous with a crisp pint, a glass of wine, or a cocktail shared with friends. However, there are early signs that this culture may be shifting, especially amongst young people. More and more Britons are cutting back on their alcohol consumption, and low and no alcohol alternatives are increasing in popularity. The trend is even more pronounced among Gen Z, with analysts finding that about a third of people aged 18-24 choose to drink no alcohol at all. Market research company Mintel believes the trend away from drinking alcohol among young people will only grow in the future.
This demographic trend raises some questions for the alcohol industry, which globally is worth an estimated market value of US$2.3tn Diageo, the world’s largest spirits producer, has been facing both short-term and long-term challenges, struggling with difficult market conditions and weakening investor sentiment. The FTSE 100 company owns a portfolio of over 200 brands, including iconic names such as Guinness, Smirnoff, Captain Morgan, Baileys, and Tanqueray. Diageo has a broad global reach, with sales in nearly 180 countries.
Diageo has recently fallen out of favour with investors, with the share price hitting a seven-year low following the release of its annual results. Earnings were surprisingly weak, with overall organic net sales falling by 0.6%. While pricing was strong, increasing by 2.9%, this was more than offset by a 3.5% decline in the volume of sales.
Poor sales in the Latin America and Caribbean (LAC) region were a major detractor, with revenues falling 21.1% compared to the previous year as wholesalers worked through elevated levels of inventory. Of perhaps greater concern was North America, which constitutes 39% of Diageo’s sales, where revenues fell 2.5% and management is warning of a cautious consumer environment. During the pandemic, many consumers stocked up on spirits for home consumption, and then in the immediate aftermath there was a surge in alcohol purchases as people returned to social drinking. This appears to be normalising now, and people working through stocked-up bottles of spirits from the pandemic is an obstacle to new sales. In addition, Diageo is increasingly focussed on more premium brands, which are significantly more profitable to sell. However, with some anxiety about the US economic outlook and high inventory levels, consumers may find themselves more reluctant to splash out on a US$60bottle of premium spirit.
Diageo is not alone in its struggle with current demand levels. Pernod Ricard, which owns brands such as Absolut, Malibu, and Jameson, recently reported a sales decline of 7%, and luxury sector giant LVMH saw organic sales in its Wine & Spirits division fall by 9%. However, these results have not come at a good time for Diageo’s management, as investor trust was already wavering. Last November the company released a surprise profit warning, causing a 11% fall in share price. It had continued to push stock into Latin America despite poor sales, raising questions about the quality of management. It has been a difficult tenure for Debra Crew, who was appointed CEO just over a year ago. During that time, both investor confidence and the share price have plummeted.
The challenges facing Diageo are undeniable, the real question is of valuation, and whether the reaction from investors has been excessively negative. After all, the company boasts a strong broad-based portfolio of brands and worldwide exposure. There are bright spots in the results, with Guinness seeing double-digit organic sales growth supported by strong demand for the alcohol-free Guinness 0.0. At the time of writing, the price-to-earnings ratio of 18.9 seems attractive, far below the 5-year median of 24.6. The share price is down over 13% so far this year and declined almost 26% over the past 12 months. Analysts at RBC Capital have recently upgraded their view to ‘neutral’ from ‘sell’, and it’s possible that there is a degree of upside from the current price. Management is ‘confident that when the consumer environment improves, the actions we are taking will return us to growth’, but the timing of such a recovery is anyone’s guess.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance. The information and views were correct at time of writing but may have changed at point of reading.