Diageo(LSE: DGE) (NYSE: DEO.US) could be one of the FTSE 100s most misunderstood and undervalued companies. The group is one of the worlds largest alcoholic beverage producers and owns many iconic brands such as, Guinness and Smirnoff Vodka.
However, despite these world-class brands, Diageo still trades at a fairly average valuation of 18.2 times forward earnings. This valuation makes the company look cheap, in comparison to other FTSE 100 world leaders such asUnilever.
Peers worth more
As a world leading producer, it seems reasonable to suggest that Diageo should trade at a premium to its smaller peers, but this is not the case.For example,peersBrown-Forman,Pernod RicardandRemy Cointreau, some of the worlds largest and most respected alcoholic beverage producers,trade at an average forward P/E of 25.9.
As covered above, Diageo currently trades at a forward P/E of 18.2. If Diageos valuation were to rise in line to that of its global peer group, then it is reasonable to assume that the companys shares would be worth 2,600p each, 42% above current levels.
And thats not all, Diageo also appears undervalued on several other metrics.
Free cash flow
Oneway to place a value on Diageo is to value the company by using its free cash flow. The free cash flow to equity multiple is a measure ofhow much cash can be paid to the equity shareholders of the company, after deducting expenses such as capital investment and debt repayment.
By calculating the companysfree cash flow to equity, and then applying a discount rate, analysts are able to place a value on the companys shares. Using this method, analysts believe that Diageo could be worth around 2,200p per share. Using this method Diageo is currently undervalued by around 20%.
Sector valuation
Additionally, theres Diageo takeover value to be considered.Specifically,Beam Inc, one of Diageos smaller peers, which produces the world famous Jim Beam Kentucky bourbon whiskey, was acquired by Japanese spirits giant,Suntory Holdingsfor $13.6bn in cash earlier this year.
Now, $13.6bn is around 20 times Beamsearnings before interest, taxes, depreciation and amortisation. Diageo currently trades at just under 13 timesearnings before interest, taxes, depreciation and amortization. If a multiple of 20 times is placed on Diageo, the companysmarket capitalisation should be 68bn, or 2,720p per share, 49% above current levels.
Long-term nature
So, its clear that Diageos current share price is undervaluing the company on several financial metrics. Whats more, Diageos defensive nature means that the company is the perfect investment for you to tuck away in your retirement portfolio and forget about.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
