Could Diageo shares be the ultimate value trap?
Was it a false start? Over the past month and a half, Diageo (LSE: DGE) had shown tentative signs of a possible recovery. Diageo shares rose 17% in barely a fortnight in August. Now, however, they are once again close to a 12-month low, 25% below where they stood a year ago.
At first glance this could look like a classic value share. On one hand it is a bit of a turnaround story, but in fact there may not even be that much to turn around. Many of Diageoâs current challenges are industry-wide, not specific to the Guinness brewer. So perhaps if it simply bides its time, the alcohol market will bounce back â and with it, Diageo shares.
Meanwhile, investors like me could be rewarded with a 4.2% dividend yield, from a company that has raised its shareholder payout per share annually for decades.
One big red flag
But what if the recent fall in Diageo shares is not an anomaly, but a sign of a shifting consumer landscape?
Both North America and Europe reported year-on-year sales declines in the first half. Diageo has been struggling with weakening demand and overstocking in Latin America and its latest results last month suggested that there could be bigger challenges than just one region. With consumer confidence getting lower in many countries, the demand for pricy tipples may fall.
That is a risk â and a big one. But I see it as essentially a short- to medium-term risk. Sooner or later, the world economy will get into a more optimistic rhythm and people will be happy to shell out top dollar for tipples, I expect.
The risk does help explain the recent fall in Diageo shares, though, to a point where they look potentially cheap from a long-term perspective.
But there is a long-term risk that could be much more fundamental when it comes to assessing the investment case for the Johnnie Walker distiller. Younger generations are drinking less than their parents and grandparents did.
What might the future hold?
That could be a cyclical trend too, that changes over time.
Or it could be an existential risk to the drinks industry.
Perhaps, 20 or 30 years from now, alcohol consumption will be in the sort of protracted terminal decline that cigarettes are now. In that case, Diageoâs strong brands and robust profits may be less attractive than they first seem, from a long-term perspective.
In other words, Diageo shares today could be a classic value trap, not the potential bargain they may first seem.
Of course, the company is well aware of the shifting environment.
It says, âmoderation presents a significant opportunity for Diageoâ. Personally, I doubt that â its drinks are already pricy, so it has limited potential to compensate for the volume hit of drinkers moderating their intake by hiking prices further.
It is also moving into non-alcoholic drinks, but that is a crowded market and I do not see it being as profitable for Diageo as its current business.
Whether Diageo turns out to be a value trap or a long-term bargain therefore turns to some extent on what happens to demand for premium alcoholic drinks over the long run. Personally I expect demand to stay high and am happy to hang onto my Diageo shares.
The post Could Diageo shares be the ultimate value trap? appeared first on The Motley Fool UK.
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C Ruane has positions in Diageo Plc. The Motley Fool UK has recommended Diageo Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
