Quality business Diageo (DGE) should benefit from a reopening of society and we think its shares will reward investors handsomely in 2021.

Diageo and the wider beverages space have underperformed a relatively buoyant wider consumer staples piece in 2020 as they have suffered from Covid’s substantial impact on sales in pubs, restaurants, hotels and at events.

We think Diageo will play catch-up in the coming months as hospitality reopens and with supermarket and convenience store sales likely to remain resilient. The market focus will soon turn to the 2022 financial year which starts in July 2021, where forecasts suggest earnings will largely recover to pre-Covid levels.

While it may be familiar to some for making Guinness, Diageo is principally a manufacturer of spirits. In the 2020 financial year upwards of 70% of its sales came from rum, scotch, vodka, whisky, gin, liqueurs, gin or tequila.

The spirits industry has several attractive qualities for a dominant player like Diageo. Consumption is steadily rising in the West and in emerging markets, manufacturing costs are relatively low, it is sold at a premium price and, crucially, brand power counts.

People will typically have a favourite brand of rum, gin, vodka or whisky. Fortunately for Diageo its roster of brands includes many people’s favourites – names like Johnnie Walker, Smirnoff, Baileys, Captain Morgan and Tanqueray.

Diageo certainly felt an impact from coronavirus, and it had to flex its balance sheet to cope with the crisis. As a result, its net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) ratio was running above its three times target at the last count.

However, we see little sign that the business is in financial distress. The dividend was hiked 2% at the half-year stage even if share buybacks were paused.

The company recently demonstrated its commitment to targeted acquisitions to refresh its portfolio by agreeing to buy Aviation American Gin, backed by actor Ryan Reynolds, in a deal worth up to $610 million.

As fund manager Nick Train, a holder of Diageo, observed: ‘It is a reassuring sign that boards aren’t just in fire-fighting mode and that balance sheets and liquidity are in good enough shape to make investments for the future.

‘As others have remarked, the deal is reminiscent of its acquisition of George Clooney-sponsored Casamigos in 2017. A transaction that raised eyebrows at the time, including ours – because of the headline cost. But a deal that looks smarter and smarter as the US spirits boom continues, with premium brands leading the way.’

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