Diageo's Credit Profile Dampens After Currency-Related Profit Warning

British alcoholic beverage company Diageo (NYSE: DEO, LON: DGE) has felt the sting of foreign currency volatility, despite the recent recovery of certain riskier emerging market assets.

The London-based firm, responsible for iconic brands, including Johnny Walker, Tanqueray, and Captain Morgan, claims to produce over 6.5bn liters of its products from more than 100 manufacturing sites in 30 countries.

Ahead of its Annual General Meeting 2018 Thursday, Diageo CEO Ivan Menezes said that while he expects organic net sales growth in its fiscal year 2019 to be consistent with its medium-term guidance of mid-single digit growth, DGE has “experienced some increased emerging market foreign exchange volatility, which has been partially offset by a strengthening of the dollar.”

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Menezes added that based on current rates “we currently expect exchange to have a negative impact on net sales of £175m and a negative impact on operating profit of £45m for the fiscal year.”

The profit warning spurred DGE’s stock lower intraday Thursday, before retracing some of its losses.

Also, the yield on its euro-denominated 2.375% notes due May 2026 pointed higher on the day, and the company’s 5-year credit default swap (CDS) spread widened more than 3bps intraday to around 32.3bps, suggesting slightly dampened perceptions about the firm’s creditworthiness.

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Analysts at Rareview Macro noted that emerging market risk assets have bounced about 3% over the past three days, amid China’s recent responses to trade battles with the U.S., including via retaliation and currency.

However, Rareview Macro questioned how emerging markets can outperform if U.S. yields pivot to a higher range, “especially if they continue to be led by ‘real interest rates’. Furthermore, Rareview Macro observed that the U.S. dollar is falling while interest rates are rising, adding that “this same decoupling of fundamentals was seen in January of this year – the broad U.S. dollar index (BBDXY) fell 4% while yields rose 25bps.”

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