Saturday, October 11, 2008 0 comments ++[ CLICK TO COMMENT ]++

Added to Watch List: Diageo (DEO)

There is indiscriminate selling in the markets right now so solid, brand-name, companies are starting to be attractive. Companies that I felt were expensive are actually reasonably valued right now. I am personally starting to concentrate on higher quality companies and moving away from the distressed, low quality, companies. Such a shift amounts to moving the modern Warren Buffett strategy of paying fair price for a good business (as opposed to paying a low price for an uncertain business.)

One company that I initially researched 2 or 3 years ago but felt was too expensive was Diageo (DEO). Diageo, a British company, is the largest spirits--hard liquor for those not familiar--company in the world. It owns many of the premier brands such as Smirnoff, Guiness, and Johnny Walker.


The alcohol industry consists of 3 segments: beer, wine, and spirits. The wine industry is heavily fragmented, and the beer industry is somewhat localized. The spirits industry is concentrated with Diageo dominating the market. (When Diageo was expensive, I also looked at its American competitor Brown Forman (BF-B) and you may want to look at that as another idea as well.)

My original macro view a few years ago was an expectation for the spirits industry to grow, possibly at the expense of the beer market. That probably won't be the case in the near future. If the economy slows down, all those living lavish lifestyles and spending a ton on spirits might stop doing so. Furthermore, beer is cheaper and some people who do not have a preference for one or the other may downgrade to beer. Growth in emerging markets may also slow somewhat in the near term (although long-term the potential is great.)

Fundamentals look attractive for Diageo. As I alluded to above, this isn't a cheap stock. You are paying closer to a fair price than a low price.

Diageo

Ticker: DEO (NYSE)
Market cap: $36 billion
P/E (trailing; forward): 14; 10.3
P/BV: 6
Enterprise value/EBITDA: 10.8
Dividend yield: 5% (not sure how sustainable the dividend is)

ROE: 40% (partly due to leverage)
Profit margin: 18.8%
Debt/equity: 2.07 (somewhat high leverage)

You can get the 10 year data at GuruFocus or the 10 year valuation measures at Morningstar.

Diageo has fairly high leverage, with debt/equity ratio over 2 (according to Yahoo Finance.) The debt is easily servicable, even in a poor economic environment, given the high profit margins. I would imagine the dividend is sustainable but any time the yield of a blue-chip is higher than long-term Treasury yields, I wonder.

The stock may drop a bit further but it's difficult to say. You can actually "make more money" by saving cash than by investing too early in bear markets. So that's something one should keep in mind during bear markets. Yes, that goes against value investing and is basically market timing, but I personally don't mind. Even if you wait for a lower price and miss it, there are many other, comparable, opportunities.

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