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Diageo (LSE:DGE) shares responded positively to the appointment of Dave Lewis. But I think investors should start making plans for a dividend cut.
When Lewis took over at Tesco in 2014, the firm suspended its dividend and it didn’t return until 2018. And while the situation at Diageo is different, there are clear challenges.
Diageo’s difficulties
Diageo’s main issue has been weak demand for its product. Cutting the dividend won’t affect this directly, but it could limit the effect on the company’s balance sheet.
The firm finished its 2025 financial year with a leverage ratio of 3.4, which is both high and above its target range. But there are a few strategies for trying to bring this back down.
Ideally, the way to do this is by growing profits, but that’s easier said than done. The reason the ratio is high is that cash profits have been falling recently, for a variety of reasons.
The alternative is to pay down debt. And one way to raise cash for this is by selling some of the firm’s weaker lines to focus on its stronger ones – a move Lewis successfully executed at Tesco.
In general, though, it’s best to be selling from a position of strength. So while it might work, I think investors should be alert to the possibility of action around the dividend.
In the context of £16.56bn in net borrowings, £1.75bn in annual dividends isn’t going to make a huge difference. But as they say at Tesco, every little helps.
Should investors worry?
I therefore think there’s a threat to Diageo’s dividend that’s worth taking very seriously at this point. But I’m a shareholder and I don’t see this as something to worry about.
That’s partly because I’m not relying on the stock for income. But in my view, even those who are should view strengthening the company’s financial position as a long-term positive.
If Diageo’s dividend gets cut, shareholders can still generate income by selling part of their investment. In fact, they might even be better off in this situation.
The stock currently trades at a price-to-book (P/B) ratio of 4.6. In other words, every £1 the firm retains on its balance sheet translates into £4.60 in market value.
Given this, investors currently have a choice between getting £1 in cash as a dividend or selling £1 in equity for £4. So there’s still a good income opportunity there for investors.
Ultimately, the firm needs to get its profits moving in the right direction. That’s what will matter for shareholders, much more than the mechanism by which they generate returns.
Chasing shadows
I think worrying about the viability of Diageo’s dividend is a bit like me worrying that my shadow looks like it’s putting on weight. It’s not a great sign, but it’s not really the problem.
The underlying issue for the company is a demand challenge. And this matters much more than whether the firm cuts or sustains its dividend.
Regardless of dividend policy, investors will be able to find ways of generating income if Diageo does well. The big question is whether the new CEO can turn things around.
