Diageo Plc is a tough stock to own right now. A growing number of headlines suggest that Gen Z is more health-conscious and, as a group, contributes to the steep decline in alcohol consumption. Statistics like the Gallup survey below can be found all over the internet, showing a clear break from historical trends.
Another telling data point comes from the US Bureau of Labor Statistics, showing a sharp drop in spending between Millennials and Gen Z.
Of course, this shouldn’t be entirely surprising, because many are still underage. Still, with some approaching their 30s, you’d expect their contribution to be at least a quarter of what Millennials consume. Yet the gap remains wide, pointing to a real generational shift in alcohol spending.
That said, Diageo’s CEO addressed this issue on the In Good Company podcast several months ago (I recommend to watch it if you are interested in Diageo):
According to her, moderation in alcohol consumption is part of a long-term trend, with the recent acceleration more tied to inflationary pressures than a sudden structural shift. Gen Z behaviors are being tracked, but she views them as less significant than macroeconomic factors, describing it with the so-called “zebra striping” effect (switching between alcohol and non-alcoholic drinks… thanks to “McKinsey” for that term 🤣).
Jokes aside, it’s an interesting perspective, and we should assume Diageo has done its homework. Still, this framing downplays the severity of the consumption drop highlighted by the aforementioned research agencies. The truth is probably somewhere in between.
Financial performance
Diageo is doing its utmost to navigate this period, focusing on keeping the dividend safe through cost-cutting programs totaling £625 million, targeting supply chain, operational efficiencies, and trade/A&P spend.
But, as I noted in my UPS write-up, management deserves criticism. They executed massive buybacks in 2022–2023, when the stock traded at a 30–40x P/E. Instead of prioritizing buybacks, they could have strengthened the balance sheet, which has seen long-term debt rise from £14.5 billion to £20 billion today.
The company bought back about 2% of shares annually during those years, but imagine the firepower it could have now for opportunistic buybacks, or even to acquire distressed rivals like Pernod Ricard, if today’s challenges truly are cyclical rather than structural.
Dividend & Valuation
This is why owning Diageo feels tough. Still, the dividend looks safe, though with limited margin. The company maintains one of the strongest alcoholic brand portfolios in the world, carries an A3 credit rating, and can afford its payout, especially if this is near the bottom of the cycle.
Valuation looks fair. The stock trades at 14.3x free cash flow and 23x earnings, this is not “cheap,” but the 4.4% dividend yield is the highest in a decade. For dividend yield theory fans, this could signal a once-in-a-decade entry point, but you must be convinced that earnings and cash flows are sustainable and growth will resume.
Running the numbers: assuming current free cash flow of £2.7 billion (below management’s £3 billion short-term goal), 4% growth for the next five years, 6% thereafter, an 11% discount rate, and a 15x terminal P/E, the fair value comes out at 1,930 pence per share, about 8% above today’s price.
Bottom line
If you believe the worst is behind Diageo, and that the company can find a bumpy but reasonable path back to growth, then today’s valuation looks attractive.