Diageo ditched in favour of cola and lager stocks

The reputation of Diageo (LSE:DGE) as a quality stock for the long term took another hit today when a City bank gave the spirits giant a “sell” rating as part of a review of European beverages.

UBS also recommends switching out of Carlsberg, with its preferred stocks in the sector now including Heineken NV (EURONEXT:HEIA) and the FTSE 100-listed bottling firm Coca-Cola HBC AG (LSE:CCH).

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The caution towards Diageo follows last month’s shock disclosure of lower consumption and downtrading by consumers in Latin America and the Caribbean. UBS thinks de-stocking in the region could last into the second half of the current financial year and that the timing of a return to market share growth in the key US market remains uncertain.

The bank prudently assumes no share buybacks in the next financial year, given the high interest rate environment and elevated marketing and capital expenditure needs until 2027.

Diageo shares are currently at a three-year low of 2,793p, with the FTSE 100 stock valued at a 12% premium to the staples sector. However, UBS said that when Diageo’s organic growth last underperformed in 2014/15 the stock de-rated to a 10% discount.

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It warns there’s a risk of a repeat until US spirits growth accelerates to mid-single digits and management draws a line under the LatAm de-stocking. UBS said it lacked conviction these inflections are coming in the second half of this financial year, as it slashed its target price from 3,650p to 2,650p.

The bank added: “Diageo has a good track record of innovation and investing ahead of category shifts, and we expect the business to return to within the 5-7% organic revenue guidance range, but only in the second half of the 2025 financial year.”

The downturn for Diageo has come six months after the drinks giant received an endorsement from the Sage of Omaha, with Warren Buffett’s Berkshire Hathaway Inc Class B (NYSE:BRK.B) disclosing the $41.3 million (£33 million) purchase of 227,750 American depository receipts.

The move was seen as part of Buffett’s long-held strategy of using market downturns to pick up quality stocks that are highly profitable with a proven track record.

The view of Diageo as a core long-term holding is one supported by London-based stock picker Nick Train, whose Finsbury Growth & Income Ord (LSE:FGT) Trust held Diageo as third-largest holding accounting for 10.7% of the portfolio at the end of October.\

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The 10th most-important stock in the Finsbury portfolio is Heineken, which today received the support of UBS at a time of pressure on European brewing industry volumes. The bank’s preference over Carlsberg reflects hopes that market share momentum can support an eventual acceleration to 2-3% volume growth by the second half of 2024.

UBS also has a “buy” recommendation on bottling business Coca-Cola HBC after it upgraded its price target by 200p to 2,500p. Such a level would represent a return to May’s 2023 peak, having last month fallen to as low as 2,065p.

The bank believes the market under-appreciates the company's strong revenue management and execution capabilities, having successfully navigated heightened volatility across its footprint in recent years.

It added: “We believe the accelerating market share trends in recent quarters and return to volume growth in Nigeria and Egypt despite tough macroeconomics bode well for the 2024 financial year.”