HSBC turns bullish on Diageo

HSBC upgraded Diageo to ‘buy’ from ‘hold’ and lifted the price target to 2,600p from 2,350p.

“After a year of extended conversations with managers across the company, we think Diageo’s often criticised corporate culture is finally evolving in the direction long hoped for by the market. This gives us optimism that management is executing more efficiently than at any time in recent memory; we are, in effect, giving the benefit of the doubt to a management team that is affecting change in a meaningful and constructive way,” it said.

HSBC explained that it kept its rating on the stock at ‘hold’ during the post-Brexit rally as it reckoned the shares were being boosted by Brexit currency tailwinds rather than fundamentals, and it would need to see more from the group before giving it the benefit of the doubt.

“But what we have now is significantly more confidence in Diageo as a commercial organisation with a stronger strategic backbone than at any time in the past.”

The bank said it was upgrading the stock for two reasons.

Firstly, it argued that operationally, Diageo is focused on meaningful cost control, benefiting from a booming and well-resourced Reserve portfolio push and stoking solid local growth stories.

“All of these we believe will continue to drive the stock from here post the Brexit vote rally.”

Secondly, it pointed out that thanks to the company’s high operational exposure to the US and the eurozone, the recent update to HSBC’s global cost of equity estimates has an immediate positive impact on its discounted cash flow valuation.

“Trading at a price-to-earnings ratio of 21.1x versus our calendar 2017e earnings per share of 103.62p, the stock remains at a 5% discount to the group average of 22.5x, making it an attractive option versus expensive peers.”

At 0927 BST, Diageo shares were up 0.5% to 2,214.50p.