Drinks giant Diageo [DGE] has been badly hit by the coronavirus outbreak, and it’s likely to see some long-term impact from the epidemic. Should traders avoid the company’s share price in the coming year?
Diageo’s share price has slumped by 8.4% following news of the dramatic spread of the virus in Italy (between 21-24 February), reaching a 52-week low of 2,599p on 10 March.
Although its share price had somewhat recovered, since rising by 4.1% up to 5 March, a recent profit warning suggests that the company – which owns brands such as Guinness, Johnnie Walker and Baileys – is set to see long-term aftershocks from the epidemic. The share price has seen a 6.4% drop since 5 March.
On 26 February, the company announced that full-year sales are likely to come in between £225m and £325m lower due to the disruption caused by the extreme disruption in China – one of Diageo’s biggest markets. The firm also said that profits will be down between £140m and £200m.
After a strong decade of growth – seeing the share price grow around 140% to date - Diageo had reported solid figures in 2019. The spirit maker reported profits of £4bn for the year ended 30 June, a rise of 9.5% on the previous year. Sales went up by 5.8% to £12.87bn.
For fiscal 2020, the company had already anticipated net sales growth would be lower, at the mid-point of 4-6%, but it foresaw sales growing between 5-7%. The new warning means that it is likely to come in shorter than this.
With a profit cut of £200m, the company will take a hit of around 5% on last year’s total. Meanwhile, sales coming in at £225-325m will represent a 2.5% reduction year-on-year compared to 2019 figures.
Although Diageo expects operations in China to return to business as usual by the end of June – when its financial year ends – it has admitted that it has not taken into account potential virus effects outside of Asia Pacific, which may lead to further surprises.
|PE ratio (TTM)||20.60|
|Operating Margin (TTM)||31.73%|
Diageo share price vitals, Yahoo Finance, 11 March 2020
Fighting against slowing APAC growth
Diageo has been battling with slowing growth in Asia Pacific, after the region’s volume sales share went down from being the highest across all regions – at 42% in FY2016 - to 37.6% in FY2018, according to Trefis figures.
The company’s FY2019 results showed that it was finally regaining ground in the region when APAC volume sales rose to 38.7%, but this is likely to be knocked back down as a result of the impact in China.
As a result of this, Diageo has been taking action in India, which has been little affected by the epidemic so far. Last week, the drink maker increased its controlling stake in Indian beverage company United Spirits to 55.9% as it continues to grow its business in the area.
Despite recent setbacks, Diageo’s solid growth in the past decade means that many still value the drinks giant’s shares.
As a result, some have suggested buying the dip in Diageo’s share price. RBC said this week that Diageo and luxury-goods conglomerate LVMH [LVMH] are among the European stocks opportunistic investors should buy after the coronavirus dip.
“Diageo is doing pretty much everything right in its pursuit of becoming a ‘reliable compounder of growth’ in our view. It’s executing the whole virtuous circle thing in an exemplary way, steadily upping investment in marketing and seeing the results in sustained revenue growth, declining cost ratios and higher margins,” RBC analyst James Edwardes Jones said.
“Diageo is doing pretty much everything right in its pursuit of becoming a ‘reliable compounder of growth’ in our view. It’s executing the whole virtuous circle thing in an exemplary way, steadily upping investment in marketing and seeing the results in sustained revenue growth, declining cost ratios and higher margins” - RBC analyst James Edwardes Jones
Elsewhere, Motley Fool writer Peter Stephens says that disrupted operations in China could mean the stock misses its financial guidance in the short run, which may lead to weaker investor sentiment in coming months. However, over the long-term, he says Diageo has “significant growth potential”.
“Although Diageo’s shares continue to trade at a premium to the FTSE 100, having a P/E ratio of 20.9, they could offer good value for money right now, due to their growth potential. As such, it could be an opportune moment to buy them and hold for the long run,” Stephens says.
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