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StockBeat: More Gin, But Easy on the Tonic Please

By Geoffrey Smith

Investing.com -- It’s been THE drinking trend of the last few years, but is the stock market telling us we’re reaching peak gin?

Shares in Diageo (LON:DGE), the world’s largest spirits maker, fell on Thursday as the company indicated that the pace of its share buybacks would slow in the coming three years, even though it said its underlying business outlook was strong.

For a mature business in a market challenged by increasing health consciousness, Diageo has had a terrific run over the last three years, rising some 85% before peaking at the start July. But the shares have fallen 6% since the beginning of the month, and the company’s report for the full fiscal year ending in June did nothing to turn them around on Thursday.

The shares lost 2.1% on a morning when the FTSE 100 was flat and most other European markets were up: the benchmark STOXX 600 rose 0.2%, while the German Dax eked out a 0.1% gain as another miserable Ifo business survey strengthened expectations that the European Central Bank will take action to support the economy.

At first glance there was little in Diageo’s update to make nervous shareholders reach for the bottle. CEO Ivan Menezes said he expected organic sales to continue growing at somewhere around 5% a year and for operating profit to rise at up to 7% a year: that’s the kind of performance that Unilever (LON:ULVR), another established consumer goods giant, can only dream about for the foreseeable future, judging by another meh quarterly update that came out at the same time.

Sales of gin and tequila continue to grow gangbusters, with revenue growing faster than volume – always a good sign.

Ironically, the reminder of the underlying strength of Diageo’s business has brought more benefit to Fevertree, the maker of upmarket mixers. Its shares rose 8.3% to their highest in over a month, after a sharp sell-off on the back of its own most recent trading update.

Clearly, the problem for both companies is less the business than the valuation: at 28 times earnings, according to data compiled by Investing.com, Diageo’s shares are not looking cheap – especially when they offer a dividend yield of only a little more than 2%. Buybacks are also slowing to an average of 1.5 billion pounds a year over the next three years, from 2.8 billion this year. However, Diageo (LON:DGE) still looks a bargain next to Fevertree (LON:FEVR), which trades at 43 times earnings despite an inevitable slowdown in its growth rate as it scales up.

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