Some FTSE 100 companies have been bracing themselves for the potential impact of Donald Trump’s proposed tariffs. One firm that could feel the pinch is booze behemoth Diageo (LSE: DGE).
Here, I’ll look at the latest news and what it could mean for long-suffering Diageo shareholders (myself included).
North American trade update
On 25 November, President-elect Trump took to his Truth Social platform to update everyone on his plans for tariffs on goods from Canada and Mexico.
Trump wrote: “On January 20th, as one of my many first Executive Orders, I will sign all necessary documents to charge Mexico and Canada a 25% Tariff on ALL products coming into the United States, and its ridiculous Open Borders.”
This wasn’t great news for Diageo, as the firm imports a load of Canadian whisky into the US through its ownership of Crown Royal. It’s also a significant player in the global tequila market, owning popular Mexican brands Don Julio and Casamigos.
Why hasn’t the stock tanked?
The Diageo share price took a brief dive following this news, but has pretty much recovered since. As I write today (28 November), it’s actually up 1.2% to 2,383p.
I assume the reasons for this are twofold. First, Trump famously loves to negotiate a deal. He even released a 1987 book, The Art of the Deal, in which he said: “My style of deal-making is quite simple and straightforward. I aim very high, and then I just keep pushing and pushing and pushing to get what I’m after.”
Therefore, this seems to just be the opening move for negotiations. If Canada and Mexico agree to tighten border security, the tariffs might not be anywhere near as high as 25%.
Second, the global spirits industry is in a downturn, with inflation-hit consumers drinking less or downtrading to cheaper brands. Diageo stock has already fallen 40% inside three years.
This has left it trading on a forward price-to-earnings (P/E) ratio of around 16.3. That’s a significant discount to previous years, suggesting much of the bad news (possibly even tariffs) is already priced in to the valuation.
Risk
However, analysts at Deutsche Bank don’t see it like that. They point out that imports from Mexico make up around a quarter of Diageo’s US sales, with Canada accounting for another 16%.
Meanwhile, Trump has previously pledged a 10% tariff on all imported goods, which would include those from the EU and UK. Factoring in all that, Deutsche Bank estimates there could be an 8% hit to Diageo’s earnings per share (EPS).
“We do not believe this level of risk is reflected in [alcohol] company valuations,” the bank added.
I’m not too worried
If these calculations are accurate, that would put the forward P/E ratio closer to 17.5 than 16.3. We might therefore see the stock take another dip as investors reassess the valuation in light of the tariffs (if they’re imposed).
Perhaps Diageo can successfully raise prices without losing sales in its key US market. We just don’t know, and this uncertainty will probably hang over the stock for a while yet.
I’m not planning to add to my position, as I’m comfortable with its current size. The forecast dividend yield of 3.7% will hopefully offer some consolation until the spirits market recovers (whenever that is).
This post was originally published on Motley Fool
