Company Trend Analysis - Diageo Wary Of Brexit Impact On Scotch - OCT 2017

BMI View: The increased likelihood of a 'soft Brexit' is good news for drinks major Diageo, which had been vocal in its support for the UK to retain its EU membership, due to its heavy reliance on European markets for its Scotch sales. Over the near-term, the company will continue to benefit from the weaker pound sterling since the EU referendum, with greater export opportunities opening up for the company.

We believe the failure of the ruling conservative government to achieve a parliamentary majority in the UK General Election in June 2017 raises the likelihood of a 'soft Brexit', and therefore continued membership of the single market ( see 'A Hard Brexit Is Now Less Likely', June 9 2017) . This is crucial for Diageo, particularly with regard to Scotch, the company's largest export, which relies heavily on sales from major European markets.

Diageo, which owns a number of Scotch brands, including global leader Johnnie Walker, has been vocal in its support for Britain to remain in the EU. Continued EU membership not only grants access to well-established whisky markets with opportunities for premiumisation, such as France, Spain and Germany, but the EU's influence as the world's largest economic bloc also provides the industry with attractive overseas trade deals with other major markets globally. Although not our core view, the failure of the UK to gain access to the single market is worth highlighting as a potential long-term downside risk for Diageo.

EU Key For Scotch Exports
The UK's Top 5 Whiskey Export Markets (volumes, tons)
Source: Trade Map

In the near term, the weaker sterling following the UK's decision to leave the EU in a referendum in June 2016 offers considerable upside to Diageo. This was a key factor in Diageo's strong revenue uplift in FY17 (See ' Diageo Delivers Strong FY17 ', August 16 2017). Reported revenue (GBP12.1bn) and operating profit (GBP3.6bn) were up 15% y-o-y and 25% y-o-y respectively. Given that the UK-based company makes over 90% of its sales abroad, the fall in the value of the pound, against the US dollar and euro in particular, provided a helpful boost to revenue growth, when translating overseas earnings back into sterling. Diageo in fact was one of only a few UK-listed companies to see its share price surge following the vote to leave the EU, as investors acted on the belief that a weaker sterling would translate into strong export growth globally.