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Many investors have been burnt by Diageo (LSE:DGE) shares over the past few years. Shockingly, this FTSE 100 stock has cratered 59% since the start off 2022!
The spirits giant has been battered by sluggish sales, weak consumer spending, generational shifts in alcohol consumption, and millions of people taking appetite-suppressing weight-loss drugs.
However, one Diageo shareholder — fund manager Nick Train — argues that even if alcohol is in long-term decline, the stock could still outperform from this point onwards. He points to tobacco stocks, which perhaps surprisingly have made investors significantly wealthier over the past 25 years.
So, might there be a once-in-a-generation chance in Diageo stock today? Let’s discuss.
1,200%+ return before dividends
On the surface, there’s a plausibility to this alcohol-might-be-the-new-tobacco argument. Back in 2000, cigarette makers were facing a steady long-term fall in volumes as more people quit smoking worldwide. Tobacco advertising had all but disappeared in the West.
Yet stocks like British American Tobacco have still made long-term investors a lot of money. At the turn of the millennium, the share price was around 325p. Fast forward to today, it’s at 4,338p, a capital appreciation of more than 1,200%.
But with dividends reinvested along the way, British American Tobacco total return is significantly higher. According to Nick Train, British American Tobacco and Imperial Brands have easily outperformed the FTSE All Share, with annualised total returns of 16% and 14% respectively this century.
That’s better than Diageo.
[E]ven a steadily declining consumer habit — cigarettes — can generate attractive investment returns, if a consumer brand company, in these examples Tobacco, is well-run to maximise cash flows, dividends and buybacks.
Nick Train
Is alcohol similar to tobacco?
Now, to be clear, Train thinks the outlook for spirits is much better than it is for cigarettes. He’s just making a point that even if he’s wrong, it doesn’t necessarily mean that his investment in Diageo has to be a bad one.
I see a couple of key differences between smoking and drinking booze, however. First and foremost, tobacco is addictive whereas drinking alcohol is a choice for most people (it’s discretionary).
This is a crucial difference because the addictive nature of the products supports tobacco firms’ pricing power. I don’t believe Diageo has anywhere near the same level of pricing power.
Indeed, I think this is part of the problem — less people are going out drinking today and some of that will be down to affordability. In the UK nowadays, a double G&T might cost £15+ in a city bar — for one drink.
Compared to that, a pack of fags might look good value!
Also, the barriers to entry are massive in the tobacco industry. No starry-eyed entrepreneurs are plotting a global cigarette empire nowadays.
In contrast, celebrities are constantly launching new gins and whiskies. Indeed, forking out for celebrity-backed labels over the years has arguably not done Diageo’s balance sheet much good.
Looking ahead
That said, Diageo might still do well from it’s low price today, especially under new management. Disposal of non-core assets should improve the balance sheet and support share buybacks. So it may be worth digging into.
However, I don’t expect Diageo to replicate the historical return of tobacco stocks over the next 20 years. It’s not a once-in-a-generation buying opportunity, in my opinion.
