Alcoholic drinks outfit Diageo (DGE) has endured a rough period of late, partly thanks to problems of its own making. We think that has put the valuation in a place where, if there are signs the business is getting its act together, the shares can deliver significant upside for investors in 2025.

Unless there is evidence of improved performance soon then activist investors could be tempted to join the share register, takeover interest could emerge and/or current chief executive Debra Crew could be pushed out. Any of these developments could, in themselves, be a catalyst for the stock.

SHARES THE CHEAPEST SINCE THE FINANCIAL CRISIS

In the past, Diageo has consistently traded above 20 times forecast earnings. Based on consensus numbers for the year to 30 June 2026 the shares are now on a PE (price to earnings) ratio of around 18 times, the cheapest level since the 2007/8 financial crisis. They offer a dividend yield of 3.5% to boot, with the company having grown its payout handsomely over the long run. 

Headquartered in London’s West End, Diageo owns several iconic brands including Johnnie Walker whisky, Smirnoff vodka and Guinness, as well as Captain Morgan rum, Tanqueray premium gin and Baileys cream liqueur. In the June 2024 financial year, 24% of sales were accounted for by scotch, 16% by beer, 11% by tequila and 9% by vodka.

As well as this enviable portfolio, Diageo has a robust distribution network and strong marketing capabilities.

However, since the untimely passing of then chief executive Ivan Menezes in June 2023 – shortly before he was due to step down to be replaced by current incumbent Crew – Diageo has served up a surprise profit warning (in November 2023) and results for the year to 30 June 2024 which undershot consensus expectations as group sales declined for the first time post-pandemic.

The company has been hit by having excess inventory in the Latin American and Caribbean region, China’s slower than anticipated post-Covid recovery and a cautious consumer environment in North America.

Despite this challenging environment, the company managed to grow free cash flow by 18% to $2.6 billion in the 12-month period and deliver a 5% increase in the dividend, and the appointment of Nik Jhangiani as chief financial officer in September 2024 could help build on this. 

Jhangiani previously served as finance chief at bottling firm Coca-Cola Europacific Partners (CCEP), where he was part of a team which delivered very strong returns to shareholders.

Bringing this experience to bear, he could help make Diageo more disciplined on costs as well as increasing the focus on cash, returns and execution.   

ADAPTING TO SHIFTING CONSUMER TASTES

One of the risks for Diageo is a reduction in spirits consumption, particularly among more health-conscious younger consumers. Drinking trends are changing, although we suspect not to the extent some would have you believe, and Diageo is adapting. Its alcohol-free Guinness Zero is seeing extremely strong growth, albeit from a low base.

Guinness in general seems to be enjoying a surge in demand with reports suggesting limits were placed on pub and bar purchases in the run-up to Christmas, with a wave of so-called ‘Guinnfluencers’ prompting increased consumption of the famous stout among women.

There are other risks to consider, including the potential impact of any new tariffs introduced by a new Trump administration. However, we think these are more than reflected in the price and see the company’s first-half results on 4 February as an opportunity to reset expectations, with the market’s focus increasingly shifting to a year of recovery in the 12-month period to 30 June 2026 through the course of the 2025.

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