UBS has reignited its coverage of Diageo PLC (LSE:DGE), the maker of Smirnoff Vodka and Baileys, with a 'sell' recommendation, painting a picture of uncertainty and potential challenges for shares in a company that has long been a staple in the portfolios of many investors.
Valuation is at the heart of the move from 'neutral' with the stock trading at around a 12% premium to other companies in the staples sector.
This premium, according to UBS, is teetering on the edge, particularly vulnerable to a decline unless Diageo can ramp up its growth in key areas with the crux of the issue lying in the United States spirits market and the ongoing destocking in Latin America.
Specifically, UBS expresses scepticism about Diageo's ability to boost its growth in the US spirits sector to the mid-single digits by the latter half of 2024. This growth is crucial for justifying the drinks giant's current market valuation.
Further south, in Latin America, Diageo is grappling with the issue of destocking. This term refers to the reduction of inventory by retailers, a move that often signals a dip in demand or an oversupply. The persistence of this trend in Latin America could spell more trouble for Diageo, potentially impacting its overall performance, UBS reckons.
One of the more immediate financial implications for Diageo, as pointed out by UBS, is the potential impact on its share buyback programme.
With the net debt to earnings before interest, taxes, depreciation, and amortisation ratio – a measure of a company's financial health – expected to rise, UBS anticipates that Diageo might not proceed with share buybacks in the fiscal year 2025.
In early afternoon trading, Diageo shares were down 0.7% at 2,792.5p.