Can There Be A Silver Lining For Diageo In The Aftermath Of The Brexit?

by Trefis Team
+6.06%
Upside
162
Market
172
Trefis
DEO
Diageo
Rate   |   votes   |   Share

As the UK voted to leave the European Union last week, there were bound to be some winners and losers on the London stock exchanges. News of the victory of the Leave campaign sent the British pound tumbling to its 31-year low, before recovering to be down 5.9%, and the FTSE 100 tanked over 8% at one point on Friday, before closing 3.2% lower. While the stock markets were in chaos, Diageo (NYSE:DEO) was seen as a winner, which closed 2.5% higher than the previous day.

Diageo vs FTSE

The company could see significant currency benefit, as a result of a falling Sterling. Since a majority of Diageo’s revenues, almost 90%, come from regions outside of Britain, a weaker pound is bound to benefit its top line. A Brexit might be advantageous to a number of UK exporters, as their goods will command more competitive prices overseas.

Diageo Net Sales By Region

Analysts at Credit Suisse noted that the positive impact of a falling pound could “more than offset the potential underlying business risks.” They further stated that such a scenario of a weaker sterling could result in a 9% to 17% rise to the  company’s earnings per share. Furthermore, since alcohol is a resilient business during economic crises, reflecting consumers’ inherent need to drink, and also, greater loyalty among its customers, it may further result in an upside to Diageo’s stock.

Brexit Winners and Losers

Fitch Ratings said in a note, before the votes were in, that UK companies, with significant foreign currency debt, would face servicing issues. In the case of Diageo, while they do have a high level of debt, most of their borrowing is in GBP. This means that as the pound falls, the bottom line will be impacted positively.

Diageo Debt

However, all British whisky benefited from the agreements reached by the EU to open up export markets. The Scotch Whisky Association (SWA) had earlier claimed that UK’s membership in the EU is “central to Scotch whisky’s success.” David Frost, chief executive of the SWA stated that EU’s single market, with its regulation of food and drink, and single trade policy, are central to the success of Scotch whisky, which had 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. The EU has managed to broker some important trade deals for Scotch whisky, as part of the Free Trade Agreement (FTA) that they negotiated around the world. This includes a deal with South Korea, wherein the tariffs on Scotch whisky were reduced to zero, and with Vietnam, where tariffs would be reduced from 45% to zero over time. With 99 million cases of Scotch whisky exported to other nations in 2014, over one billion pounds could be at risk as a result of the Brexit. Furthermore, it is as per EU law that the term ‘Scotch Whisky’ is under protection of Geographical Indication, just as Champagne is protected for wine produced in the Champagne region of France. While the Leave campaign cited EU’s inability to renegotiate a deal with India, a potentially enormous market, where the tariffs for Scotch whisky are at an astronomical rate of 150%, the SWA are not pleased with the result, as it may not only lead to a reduction in the number of jobs, but may also cause higher tariffs and increased paper work, which will result in higher costs.

Have more questions on Diageo? See the links below:

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.
Rate   |   votes   |   Share

Comments

Name (Required)
Email (Required, but never displayed)
Be the first to comment!