Two underperforming FTSE 100 stocks with recovery potential

While the FTSE 100 index is flat year-to-date, a number of its members have fallen heavily. For instance, beverages firm Diageo (LON: DGE) and luxury goods company Burberry (LON: BRBY) have both recorded 12% share price declines this year.

In the short run, they face uncertain operating conditions that could lead to further stock price volatility. But, on a long-term view, they have the potential to reverse their recent index underperformance to generate attractive capital returns.

Burberry

Covid-19 continues to have a negative impact on the Burberry share price. Restrictions in China inhibited its latest comparable store sales growth figures, with them growing by a relatively modest 7% in the final quarter of its financial year.

Of course, the company has a new CEO who will unveil his growth strategy later this year. Alongside likely continued uncertainty caused by the pandemic, this may mean that Burberry’s shares remain volatile in the coming months.

However, its strong brand means it is in a good position to offset high inflation with price rises. Indeed, its latest full-year results showed a rise in adjusted gross margin of 60 basis points to 70.6%. The firm also stated that it is “actively managing the headwind from inflation.” This capability could prove useful in an era of heightened global inflation.

Burberry’s continued focus on digital growth and in its refreshed store concept could further improve its market position as consumer trends evolve. Its investment in areas such as outerwear and leather goods has had a positive impact on financial performance, with them delivering sales growth of 39% and 28%, respectively, versus the 2020 financial year.

Although the company trades on a rich price-to-earnings ratio of 16.3, it is forecast to post a double-digit rise in earnings per share over the next two financial years. As a result, it offers good value for money on a long-term view.

Diageo

Diageo’s share price has fallen this year in spite of favourable currency movements. The firm generates 40% of its sales from North America but reports in sterling. With the dollar having become increasingly viewed as a safe haven currency, and having the potential to remain so due to impending US interest rate rises, the company’s recent financial performance is likely to have benefitted.

Its latest half-year results showed that it delivered a 190 basis point increase in operating margin. It was able to make savings in its supply chain and increase prices to more than offset higher inflation. It has the capacity to continue this trend in future due to it having an array of strong brands that command significant customer loyalty.

Clearly, the prospects for on-trade consumption could deteriorate due to weak consumer confidence in an era of high inflation. However, as was shown during various lockdowns, consumers may switch consumption to off-trade channels. A weaker short-term industry outlook may also present acquisition opportunities for Diageo due to its solid financial position.

Diageo’s share price has a price-to-earnings ratio of 32 at the present time. While this is extremely high versus other FTSE 100 stocks, its forecast growth rate in earnings of 15% per annum over the next three years suggests it offers recovery potential following its recent FTSE 100 underperformance.