RBC Capital 'reluctantly' downgrades Diageo

Diageo traded lower on Monday after RBC Capital Markets "reluctantly" downgraded the stock to 'sector perform' from 'outperform' as it cut the price target to 2,400p from 2,600p.

RBC said it's been a long time since its recommendation depended not on what it anticipated about the trajectory of Diageo’s "often erratic" financial performance, but what multiple to apply to that increasingly predictable financial performance.

"Diageo’s business is in a good place and executing competently, but the shares' valuation reflects this."

The bank had been hoping that good interim results would allow it to bump up its forecasts and price target. Although the results were good, as hoped, RBC edged down its forecasts and adjusted present value-derived price target, meaning there was little alternative but to downgrade the stock.

RBC said the company is in enviable position, with its biggest markets - the US - remarkably robust compared to other categories, while big incumbents enjoy formidable barriers to entry, at least in brown spirits. In addition, Diageo is increasing market investment, unlike many of its sector rivals, which RBC said gives it "a degree of confidence" about the sustainability of revenue.

However, it added that while cash flow is improving, it's not improving as much as the bank had hoped.

"In our view there’s plenty of scope for both working and fixed capital to be managed more tightly, but we think investment will be less aggressively curtailed than we previously anticipated. Cash conversion, although much improved, looks set to remain in the bottom half of a peer group of consumer staples businesses.

At 1500 GMT, Diageo shares were down 1.5% to 2,521p.