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Diageo (LSE: DGE) shares have staged a remarkable comeback, soaring 38% from their March lows. After a bruising period for the drinks giant, could this be the moment everything finally starts to turn around? Or are investors getting ahead of themselves?
Q1 27 trading update
Diageo’s latest trading update looks like a bit of a mixed bag to me. There are reasons to be encouraged, with sales returning to growth and some of its biggest brands showing signs of strength. Guinness, whisky and Smirnoff Ice all delivered growth, while Latin America and Asia Pacific put in particularly good performances.
As an existing shareholder, that’s encouraging. But I wouldn’t conclude that the drinks giant is out of the woods. Far from it. Strip out the contribution from East African Breweries (EABL), which it’s in the process of selling, and organic sales growth was a pretty modest 0.6%.
Management has kept its full-year forecasts unchanged too. That’s hardly a ringing endorsement of a rapid recovery. For me, this is a small step in the right direction. So what could be the spark that ignites the next leg in the recovery?
Key to a sustained recovery
For me, the biggest piece of the recovery puzzle is the US. After all, North America accounts for over a third of Diageo’s total sales.
Unfortunately, the latest numbers don’t make particularly encouraging reading. Organic sales in the region fell 3.6%, with volumes down 3.7%. That’s concerning. Diageo isn’t simply facing a problem with consumers trading down to cheaper alternatives. Its overall sales volumes are falling, while price and mix are contributing virtually nothing to growth.
This raises a bigger question for me. Is the cost-of-living squeeze changing the way Americans think about spending on alcohol?
When household budgets are stretched, consumers don’t necessarily just switch to cheaper products. They might drink less frequently, rethink what represents good value, or discover alternatives they wouldn’t previously have considered. And once those habits become established, they can be difficult to reverse.
That’s potentially a longer-term problem for Diageo. Its premium brands have been a major part of its growth strategy. If consumers become less willing to pay extra for them, the company could find it harder to return to previous levels of growth even when spending conditions improve.
Where next?
I think Diageo needs to get back to basics in America. Its turnaround plan’s in full swing, but the bigger challenge is winning back consumers at a time when spending remains under pressure.
That means finding creative ways to reconnect with customers, giving them reasons to choose its brands and rebuilding demand rather than simply relying on price increases. Until we see a sustained improvement in US volumes, I’d be reluctant to call this a genuine turnaround.
A year ago, I thought Diageo shares looked oversold and offered an attractive recovery opportunity. I’m not quite so convinced today. With consumer behaviour potentially changing and management keeping its full-year guidance unchanged, I’m not rushing to buy more shares just yet.
There’s undoubtedly potential for a recovery, but I’d like to see more convincing evidence that the business is getting back on track before becoming more optimistic.
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Andrew Mackie owns shares in Diageo.
This story originally appeared on Motley Fool
