How Will Brexit Impact Diageo?

+22.70%
Upside
146
Market
179
Trefis
DEO: Diageo logo
DEO
Diageo

Diageo (NYSE:DEO) is among a growing list of companies warning its employees of the numerous risks of a withdrawal by the UK from the European Union. Chief Executive Ivan Menezes says it is “better for the UK, better for Diageo, and better for the Scotch whisky industry that we remain in.” He also noted that being a part of a single market has benefited the company immensely. Another point of contention is the trade deals in place. Currently, the UK has free trade agreements with all the countries in the European Union. Furthermore, as a part of the EU, UK companies also benefit from the trade deals in place with other countries. According to Menezes, the EU has so far concluded, or is negotiating, over 50 of these global agreement deals, many of which will provide enormous commercial benefits to Diageo. If UK decided on leaving the EU, it will take years to renegotiate such trade deals. Even if the region is ultimately successful in its negotiations, their terms may not be as good as those which exist today. The Scotch Whisky Association (SWA) also made its position clear with regards to the upcoming vote on June 23rd, claiming that the UK’s membership in the EU is “central to Scotch whisky’s success.” David Frost, chief executive of the SWA states that EU’s single market, with its regulation of food and drink, and single trade policy, are central to the success of Scotch whisky. It has not only made trade across the EU easy and simple, but also, given EU’s weight and expertise in international trade, aided in giving fair access to overseas markets.

Brexit Impact

Investment bank UBS has warned that the FTSE 100 could crash below 5,000 within days if Britain votes to leave the EU, plunging 21% from its current level to 4,900, in the short-term. More conservative analysts view the fall to be closer to 5,500. If London’s benchmark index plunges to a low of 4,900, it could wipe out over £346 billion off its value, making it the worst fall in its history. On the contrary, if Britain votes to stay in, the FTSE 100 could rally by as much as 9%. The pound has fallen considerably since the December 17th, 2015, announcement by David Cameron confirming the vote. According to analysts at Goldman Sachs, the Sterling will collapse by 20% in the event of a Brexit. On the first trading day after Mr. Cameron set the date for the Brexit vote, the Sterling dropped 1.3% against the dollar, its largest fall since May 2015.

GBP against USD, EUR

Severing of ties with the EU would also falter the growth prospects for Britain. Stephanie Flanders, chief market strategist for Europe, JPMorgan Asset Management, said that one percentage point could be taken from the growth rate in the event of a negative result, 12 months after the vote. This would be a significant hit, given the forecast of a growth of 2% in 2016.

Brexit Trade Deals

The OECD recently cut its UK growth forecast from 2.1% in February, to 1.7%, and warned that a Brexit would result in economic uncertainty and hinder trade growth. Annual UK GDP growth could be reduced by 0.5 percentage points each year up to 2018. The report further stated that UK GDP would be lower by 3% by 2020, and GDP in the rest of EU would be cut by 1%. The tumbling of the sterling post an exit can be assumed because if the GDP falters, the Bank of England will resume its quantitative easing program, which while increasing the supply of money, would also weaken the currency. All these will be reflected in the DEO shares. As NYSE-listed Diageo shares are American Depository Receipts (ADRs), they are indirect holdings in the London-listed Diageo. Hence, when the dollar strengthens against the pound, the Diageo share price would fall.

Brexit GDP

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Diageo.