Diageo: double upgrade explained

America’s liking for Diageo (LSE:DGE) brands Don Julio and Crown Royal today prompted a City bank to recommend the FTSE 100 company’s shares for the first time in two years.

The double upgrade by UBS ditches its previous Sell stance, which it adopted in December 2023 when shares were still above 2,800p.

The stock fell to a multi-year low of 2,300p in early November after Donald Trump’s election win fuelled fears over the potential implementation of tariffs into the US and China.

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Shares have been on the recovery trail during December, with sentiment helped by signs of US outperformance as well reports of Guinness shortages due to high levels of pub demand.

UBS said the American acceleration had been disproportionately driven by tequila drink Don Julio Reposado and the recently launched Crown Royal Blackberry-flavoured whisky.

Its analysis of industry figures estimates Diageo’s US “sell-out” growth at 3.6% in the half year to November, versus a weak US spirits industry at about 1% lower.

The company boasts an estimated 30% share of the global premium spirits market, with its other brands including Johnnie Walker, Smirnoff and Ketel One vodka and Gordon's gin.

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UBS added: “We see scope for Diageo continuing to outperform in the US, with its two strongest-performing brands showing very strong growth, which we think is sustainable.”

On Crown Royal, it said the blackberry innovation is not showing signs of impacting the core brand or other flavours, and has proved to be incremental to the Crown franchise.

“We expect distribution gains to build as it becomes a permanent line extension,” it added.

Having seen earnings downgraded by 31% over the past two years, the bank thinks Diageo investors can gain comfort that the business is towards the end of its downgrade cycle.

Its new price target of 2,920p, up from 2,300p previously, is based on an enterprise value of 22 times net operating profit after tax. This premium to peers reflects a scarcity value associated with businesses delivering good underlying growth in developed markets.

The bank’s wider note on the European beverages sector forecasts another year of US spirits industry volume decline, but with Diageo and fellow Buy rated Davide Campari-Milano NV Az nom Post Frazionamento (MTA:CPR) set to see pockets of outperformance due partly to their tequila exposure.

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Although trends in the sector are not getting worse, UBS expects the period of underwhelming organic growth to persist in the first quarter and the first half of 2025.

It said that pricing will remain a challenge, especially in US Spirits and parts of Europe, while emerging markets are mixed with China still weak without major stimulus.

UBS’s positive stance on Diageo is in contrast to a note published earlier this month by Deutsche Bank, which cut its price target from 2,000p to 1,970p.

The bank highlighted the three Ts of Tariffs, Temperance and Trade Down as reasons for its continued caution towards European distillers and brewers such as Diageo.

It warned that Remy Cointreau (EURONEXT:RCO), Diageo, Campari and Pernod Ricard SA (EURONEXT:RI) have the highest risk from US tariffs, while Remy and Pernod have the highest risk from tariffs into China. Emerging market currency risk is another source of potential volatility.