Rising Health Concerns And Tougher Regulations Will Erode Margins

Key Takeaways

• Shifting consumer preferences and regulatory pressures threaten Diageo's volume growth, premiumization strategy, and ability to sustain margins.
  
• Cost inflation, supply chain challenges, and competition from non-alcoholic and craft brands limit prospects for revenue growth and market share retention.
  
• Premiumization, targeted emerging market growth, commercial efficiency, strategic portfolio management, and innovation in response to shifting consumer trends all strengthen long-term earnings potential.

Catalysts

Engages in the production, marketing, and sale of alcoholic beverages.

• Diageo faces a prolonged headwind from increasing global health awareness and the spread of anti-alcohol sentiment, with company commentary explicitly acknowledging a multi-year trend toward moderation, reduced occasions, and consumers switching to low
• or no-alcohol alternatives. This trend threatens to structurally erode volumes, pressure top-line growth, and undermine the effectiveness of premiumization strategies.
  
• Ongoing demographic challenges from aging Western populations, combined with the company's own acknowledgment of weak consumer environments in the US and China, are likely to contribute to persistently sluggish volume growth and declining per capita consumption in historically key profit centers, putting sustained pressure on revenues.
  
• Intensifying regulatory pressure, including higher excise taxes, advertising restrictions, and government interventions in key markets such as China, increases the risk of operating margin compression and creates uncertainty around Diageo's ability to pass through cost inflation or maintain premium pricing.
  
• Heightened supply chain complexity and persistent cost inflation for key inputs, such as agave and packaging, threaten Diageo's net and operating margins. The benefits of recent cost-savings measures will likely be offset by ongoing volatility in commodity prices and logistics, as well as by competitive pricing pressures.
  
• The rapid proliferation of non-alcoholic and low-alcohol alternatives, coupled with increased share gains from local and craft competitors, is set to cannibalize traditional spirits demand and erode Diageo's market share and pricing power, constraining both future revenue growth and margin expansion.

Diageo Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Diageo compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Diageo's revenue will grow by 1.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 11.6% today to 18.5% in 3 years time.
• The bearish analysts expect earnings to reach $3.9 billion (and earnings per share of $1.75) by about August 2028, up from $2.4 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 16.6x on those 2028 earnings, down from 26.0x today. This future PE is lower than the current PE for the US Beverage industry at 25.2x.
• Analysts expect the number of shares outstanding to grow by 0.07% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.82%, as per the Simply Wall St company report.

Diageo Future Earnings Per Share Growth

Risks

• The continued global shift toward premiumization and the strong performance of core premium brands like Johnnie Walker, Don Julio, and Guinness position Diageo to realize increased pricing power and margin expansion, which could drive higher earnings and support share price appreciation over time.
  
• Targeted expansion into high-growth emerging markets, combined with localized, market-specific strategies in regions such as Africa, India, Latin America, and Southern Europe, may capture the long-term growth potential offered by rising urbanization and a growing middle class, leading to sustainable revenue growth.
  
• Ongoing investment in commercial execution, digital transformation, and route-to-market optimization-such as increasing direct-to-consumer engagement and advanced analytics-could significantly improve marketing efficiency and operating leverage, resulting in higher net margins in the long term.
  
• Active portfolio management, including strategic acquisitions in fast-growing premium categories and divestment of non-core assets, is likely to enhance overall portfolio returns, concentrate capital on higher-margin brands, and fuel long-term earnings growth.
  
• Diageo's innovation pipeline in non-alcoholic and low-alcohol beverages, as well as its proactive approach to sustainability and evolving consumer preferences, positions the company well to mitigate risks of rising health consciousness and regulatory changes, thereby sustaining customer loyalty and stable revenue streams.

Valuation

• The assumed bearish price target for Diageo is £17.69, which represents two standard deviations below the consensus price target of £23.19. This valuation is based on what can be assumed as the expectations of Diageo's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £26.98, and the most bearish reporting a price target of just £16.98.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $21.1 billion, earnings will come to $3.9 billion, and it would be trading on a PE ratio of 16.6x, assuming you use a discount rate of 6.8%.
• Given the current share price of £20.32, the bearish analyst price target of £17.69 is 14.9% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.