A "Sin" Stock with growth and value characteristics

Diageo DEO: is a 122 year old UK based liquor, beer and wine producer and distributor to 180 countries across the globe. It is the largest company in the world of its kind and has the majority market share, particularly in Asia. Its products are skewed toward premium brands. 8 of the top 20 brands in the world are owned by DEO including Guiness and Cuervo. Diageo has even put a foothold in "Second Life", the famous online multiplayer game (see picture above).

Bull Case for DEO:

1. secular product supposedly "recession-proof"
2. product obsolescence not an issue in an industry with a very slow rate of change
3. some inventory (i.e. Scotch which is the fastest growing product segment) actually increases in value over time!
4. double digit growth in Asia
5. predictable cash flows (almost $3 Billion/year!) and fat net margins exceeding 20%
6. distribution scale and efficiency (along with valuable brands) gives DEO a wide economic moat
7. being based in the UK, revenues (and the stock price) are measured in the British pound: historically one of the most stable world currencies
8. eye popping ROE > 35%
9. dividend 3.4%
10. Morningstar's fair market value = $112/share v.s. recently trading around $70/share--> a 38% discount
11. 75% of executive compensation is performance based, helping to align their interests with shareholders
12. Enterprise value/EBIDTA = 12: cheap historically for a stable, highly profitable company that deserves a multiple premium

Bear Case:

1. subject to adverse legal/social exposure ("sin" product)
2. ethical funds and investors will generally avoid alcohol purveyors, narrowing the market exposure ever so slightly
3. subject to heavy tax burden that may increase in the future
4. European market has a been an exceptionally slow grower for the company. Europe has also seen more intense competition and subsequent margin compression
5. foreign exchange risk of British Pound v.s. loonie/USD
6. Not cheap by conventional valuations: P/E (trailing) 17 P/B 6 PEG 1.44

The recent run up in the market has spoiled my opportunity to enter a position in DEO. I'd be interested at any share price < $70/share and hold for the very long term. I think that this is an excellent investment with a considerable margin of safety.

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