Citi cuts targets for Diageo after surprising LatAm weakness

Citi has slashed its target price for Diageo by 15% after the drinks group's disappointing trading update on Friday, saying there's a risk of further cuts despite last week's derating.

The bank cut its target price from 3,600p to 3,050p and kept a 'neutral' rating.

"Despite the biggest one-day fall in Diageo’s history, it is tough to see a catalyst for the shares," Citi said in a research note on Monday.

The Smirnoff and Guinness owner had said back in September that it expected first-half organic net sales growth to pick up from the second half of last year ended 30 June. But Latin America and the Caribbean (LAC), one of its five key regions which accounts for 11% of group net sales values, is now expected to see an organic net sales decline of more than 20% in the second half compared with last year.

As a result, organic operating profit growth for the group as a whole is now expected to decline in the first half mainly due to LAC's declining sales, higher trade investment, lower operating leverage and adverse mix resulting from downtrading, Diageo said.

Citi said that the scale of the LAC weakness came as a surprise. And even after cutting earnings forecasts by 7% for the current year to 30 June, the bank said Diageo's shares are trading at just a 1% price-to-earnings discount to sector rival Pernod Ricard.

"Some may argue the worst is past and a LatAm reset maybe required at Pernod. However, given Pernod’s lower exposure to LatAm scotch, greater RTM visibility and already lowly set OSG estimates, the scale of any incremental downgrades is likely to be negligible," Citi said.

"Overall, the valuation de-rating of spirits appears to be largely complete and Diageo’s buyback should provide a floor for the stock, but with LatAm destock issues possibly lingering into H2 24E and given cuts to H1 24E US OSG, it is not yet certain these Diageo downgrades will be the last. We prefer Pernod."