Crisis? What crisis? Diageo is continuing to have a good time with no sign of a hangover

Its financial position and the defensive characteristics of premium alcoholic drinks give it a more stable outlook than many peers

Two years ago, inflation was little over 2pc and interest rates were just 0.1pc. Today, they stand at 10.1pc and 4.5pc, respectively. However, any investor who correctly predicted in May 2021 that doubledigit inflation and an ultra-fast pace of monetary policy tightening would materialise within two years was most likely derided by their peers.

Indeed, the Bank of England’s current expectation that inflation will decline to roughly 3pc by the second quarter of next year has already been dismissed by many investors who feel that fast-paced price rises will prove to be sticky. The central bank’s recent upgrade to its forecast for the UK’S economic outlook, with growth rather than a recession now anticipated this year, has also been met with a degree of scepticism in some quarters.

In Questor’s view, the past two years show that the investment world can change at a rapid pace which surprises even the most experienced market participants. Even over a limited period, the outlook for equity markets can dramatically worsen or significantly improve. As a result, our wealth preserver portfolio seeks to own stocks that can perform relatively well across a variety of economic and investment conditions.

Alcoholic beverages company Diageo, for example, is successfully overcoming a difficult period for the world economy. Its organic net sales grew by 9.4pc in the first half of its financial year, while its organic operating profit margin increased slightly despite the presence of rapidly rising input costs. The company was able to raise prices in response to rampant inflation, with its high degree of customer loyalty proving to be extremely valuable. It also made efficiencies that helped further offset the impact of elevated inflation on profitability.

The company has used an uncertain operating environment to strengthen its competitive position, with its trade market share either growing or being maintained across three quarters of its global markets during the first half of the financial year. It has also made several acquisitions over recent years that are aiding a “premiumisation” strategy which seeks to shift its product portfolio to more expensive beverages that are gaining in popularity among consumers.

With the world economy’s outlook expected to improve in 2024 and over the coming years, the company’s growth prospects are set to receive a boost. In particular, China’s reopening following the end of its zero-covid policy towards the end of last year could act as a positive catalyst on Asia’s economy. It remains a key growth area for consumer goods firms because of the existence of several

‘The company was able to raise prices in response to rampant inflation’

large and fast-growing emerging economies in the region.

The upcoming retirement of Diageo’s longstanding chief executive, who has been in position for a decade, is unlikely to materially affect its share price. The current chief operating officer is due to take over in July and, since it is an internal appointment, the management change is unlikely to prompt a major shift in the company’s financial prospects or strategy in this column’s view. Indeed, the company’s solid financial position and the relatively defensive characteristics of premium alcoholic beverages mean it has a more stable outlook than many of its FTSE 100 index peers. Therefore, should the world economy’s prospects deteriorate over the short run, which cannot be ruled out, it still offers the potential for index outperformance.

Trading on a forward price-toearnings ratio of 21.3, the company’s shares are by no means cheap at a time when many FTSE 350 stocks are priced significantly below their intrinsic value. But with the company offering a relatively robust financial outlook, emerging market exposure and long-term growth potential as it delivers on its “premiumisation” strategy, Questor believes it is worthy of its rich valuation. Since being added to our wealth preserver portfolio in July 2021, Diageo’s shares have risen by just 3pc. This is clearly disappointing, especially when the FTSE 100 has gained 9pc over the same period and inflation remains above 10pc.

However, its ability to grow profit margins during an era of extreme inflation and capacity to perform well across a variety of economic conditions highlight its long-term appeal. With the investment environment and economic outlook having the potential to change rapidly and in contrast to consensus opinion over a short space of time, as witnessed over the past two years, it continues to merit a place in our portfolio.