"If you're producing in Europe and selling into the UK, Brexit will hit you with a double-whammy" - Interview, Francoise Sonneville, Rabobank senior beverages analyst
Rabobank released its note on Brexit earlier today
Earlier today, Rabobank published a note looking at the likely effects on the drinks industry of the UK's decision to leave the European Union. Francoise Sonneville, senior analyst for beverages at Rabobank and the note's author, spoke to just-drinks yesterday.
just-drinks: How has it been, trying to predict the effects of the referendum result?
Francoise Sonneville: It's been very difficult. The result itself was very hard to predict. The night before the result came out, we were with the bookmakers in thinking it was more likely to be 'Remain' than 'Brexit'. Looking now at the facts, there are so many different layers that can still make it quite difficult. Some companies who we thought would be severely impacted, for example, actually have hedges in place. Then, some companies have investment programmes, and they see the result as being more positive for them; they can make their investments now in a cheaper way.
There are a lot of general things you can say, but for individual companies you need to really be able to look into their kitchens to find out how they will really be affected.
j-d: Your note flags the short-term currency volatility impact and the longer-term trade barrier issues. What other areas of concern do you foresee?
FS: For everyone, there is now the threat of a new global recession. Not just in the UK, but in other regions as well, growth rates have come down. It's very difficult to predict what that will do to certain products. In the most recent recession, we saw people take fewer holidays, but go out more to the on-premise, for example. Or, some people traded up to reward themselves, while others traded down as they tightened their belts.
j-d: After 2008, the 'middle' price segment of the drinks market was squeezed, with the high-end and the value areas holding share or even growing. Do you foresee this happening again post-Brexit?
FS: That is a trend that went on for a little bit longer. If you look at private-label and craft developments, those are two very good examples. That took effect across all categories and across all regions. We'll probably see more of the same here.
j-d: Would you say that the drinks industry is well-positioned for a downturn, then?
FS: I think so. When you look at the sales of Prosecco compared to the sales of Champagne, there has been a lot of change. Considering lower economic growth, it is difficult to conclude whether Champagne will do better than Prosecco, or the other way around.
Francoise Sonneville, Rabobank's senior analyst for beverages
j-d: Looking at specific companies, Diageo looks like it will be one of the short-term winners. Does it have the best company model to see out Brexit?
FS: The way we look at it is we draw up four quadrants: a UK company selling in the UK, a foreign company selling in the UK, a foreign company selling abroad and a UK company selling abroad. What you see with Diageo is that they bring back all of their profits into Sterling - they've got a very positive translation effect. Their earnings should go up, then, as their Euro and Dollar results will be higher in Pounds.
For many UK companies, having production costs in Sterling might have some transaction effects as well. A global company like Diageo, though, has production facilities all over the world, so their cost price effects will be quite limited. There will be variations between companies who produce in the UK and companies who produce in France, for example.
j-d: Which is the worst quadrant to be in?
FS: If you're producing in Europe and selling into the UK, that's where you get a double-whammy. Say, you're a Swedish cider company with costs in Krona, who sells cider in the UK: Then, there's a big risk that your costs will have gone up - with local competition in the UK, it will be hard for you to pass on these costs to the consumer - and your profits in Pounds will be worth less when you get them back to Scandinavia. But, you have to be careful about drawing too many conclusions - the company in this example may have hedged before the vote, or they may have some investments in other currencies that could help them offset.
The other group of companies that could have quite a lot of trouble is those who can't do anything to their production chain. If you have a product with GI status - meaning it must be produced in a certain place - you've got much less flexibility than when you are free to produce anywhere. Should tariffs be introduced, if you are a Champagne producer, for example, then you can't move your bottling to the UK.
j-d: How big is the temptation for companies to focus their efforts on different markets altogether?
FS: Outside of Western Europe and North America, there is organic volume growth in markets in Asia, Latin America and Africa. That said, the value growth in these markets is slow. In the M&A arena, you need to be quite specific about what you're looking to buy in Western Europe. If you're looking to fill a gap in your portfolio, yes. If you can take a product to a higher level, yes.
If you're a company in an area where the currency has not weakened, then buying a UK company becomes cheaper in your local currency. The drawback can be that your future earnings are going to be in Sterling - that's something to take into account. When you see large devaluations, the seller usually looks at the deal from a different perspective and might not price everything at the expected cost price.
j-d: It has been a tumultuous couple of weeks here in the UK. Can you please tell us something that will help calm us down?
FS: Sure! Consider this example: A Norwegian salmon farmer exports to Europe. He's got some tariffs to deal with on the value of the product he takes across the border. What he does is move the processing of the salmon just across the border to Sweden. The product entering the EU now has a lower value, because it is being made 50 miles down the road. So, if the UK does suffer from the introduction of tariffs somewhere down the road, if the Pound's devaluation continues and if labour costs rise, it might be worthwhile moving production across the Channel and shipping it over.
Fine Wines/Champagne and Spirits in the United Kingdom
A combination of consumer health concerns surrounding alcohol intake, and overall premiumisation of alcoholic drinks, with the quality of standard products improving, is causing concern for producers ...read more
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