Shares in Diageo (LSE:DGE) just fell 12.5% today (25 February) as the FTSE 100 firm announced a 50% dividend cut. I’m a shareholder, so what should I do with my investment now?
Warren Buffett says it’s never a good thing when a company cuts its dividend. But in some cases, it can be the right decision and I think that’s the situation here.
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No surprise
The share price has reacted violently to the latest news. In doing so, it’s reversed virtually all of the gains it had made since Sir Dave Lewis took control.
My view, though, is that investors shouldn’t be surprised. I said back in December that I was making plans for a potential dividend cut and suggested that other investors might want to do the same.
One reason is that it’s not at all uncommon for a new CEO to want to start from scratch, especially in a turnaround situation. And cutting the dividend was one of the first things Lewis did at Tesco.
Since then, reports have emerged that Diageo is looking to sell off some of its non-core assets to raise cash. But doing that while sending cash out as dividends would be a strange use of capital.
Strategic outlook
As well as the dividend cut, Diageo reported plans to focus on being more competitive on pricing. This is likely to result in lower margins, but the hope is that volume growth should make up for it.
The spirits market in the US has been stable and the declining sales have come from losing out to competitors. But I’m wary about the change of strategy in the current environment.
The situation in the US is that inequality is widening. Low-income households have faced increasing pressure on budgets while higher earners have generally been relatively immune.
In that environment, trying to boost the mass market appeal of Diageo’s products looks like a risk to me. It involves moving away from the firm’s identity as a company focused on premium products.
What I’m doing
The dividend cut might be a bad thing for investors looking for income in the next couple of years. But from a long-term perspective, I think the move is the right one for the business.
While I’m not fully convinced about the change in strategy, Diageo does have some key strengths that can make this approach effective. One is the scale of its distribution.
In general, companies that are looking to compete on price need some way of keeping their own costs down. And economies of scale are a really good example of this.
As a result, I’m cautiously optimistic about the future for the company. So I’m planning to hold on to my shares for the time being and see how things go.
No sale
I’m fully on board with Diageo’s decision to cut its dividend. I’ve thought for some time that this might have been on the cards and I think it’s the right thing to do.
I’m less convinced, though, about the shift towards competing on price. But at today’s prices, I think there’s good value on offer, which is why I’m not looking to sell after today’s announcement.
This story originally appeared on Motley Fool
