25% tariffs! Where next for the Diageo share price?

The Diageo (LSE: DGE) share price has been weak for some time — falling 21% in one year, 34% in two, and 42% since the end of 2022.

Now, it might be set for more pain after President Donald Trump imposed sweeping tariffs on imported goods from Mexico, Canada, and China over the weekend.

How does this impact Diageo? Let’s take a look.

A bitter-tasting development

Tariffs are like extra taxes placed on goods coming into a country. While they don’t charge the company exporting the goods (Diageo), the firms that import them (US liquor distributors) will have to pay the extra cost.

Starting this month, most goods exported from Mexico and Canada to the US will be hit with a 25% levy, while a 10% tariff has been imposed on products from China. To protect their profits, the affected importers could increase prices or seek alternatives.

Now, some companies will choose to set up or increase manufacturing in the US to escape tariffs (Trump’s intention). I note that last week Diageo North America announced plans to open a new manufacturing and warehousing facility in Alabama.

But the FTSE 100 company is in a bit of a sticky spot with regards to tequila and whisky. By law, tequila can only be produced in designated areas in Mexico, while Canadian whisky must be distilled and aged across the northern border. So Diageo-owned Crown Royal is in the firing line, as are its premium tequila brands Casamigos, Don Julio, and DeLeón.

Yet Trump might not be finished, as the UK could also be hit with some sort of tariff. That might impact Scotch brands like Johnnie Walker.

All of this has the potential to lower demand and hurt Diageo’s sales in its largest market. In November, Deutsche Bank estimated that it could result in Diageo’s earnings per share (EPS) being around 8% lower.

Ready for a rowback?

Just a few years ago, it was all so different. In 2021, interest rates were at near-0% and cashed-up consumers were stuck at home during lockdowns, treating themselves to pricey bottles of spirits. This was hardly surprising, as there was a lot of external doom and gloom to drown out.

At the time, Diageo forecast medium-term annual sales growth of 5% to 7%. But that projection is looking far too optimistic now. Personally, I expect the firm to row back on that tomorrow (4 February) when it reports its half-year results. And the 25-year record of dividend growth might be in jeopardy.

My move

It’s a big week for the company, with the earnings call certain to focus on tariffs. My fear as a shareholder is that management adjusts its sales targets downwards and blames the looming threat of GLP-1 weight-loss drugs. These can supress a desire to drink alcohol, and fund manager Terry Smith cited them as one reason why he sold his Diageo holding last year.

We suspect the entire drinks sector is in the early stages of being impacted negatively by weight-loss drugs.

Fundsmith Equity manager Terry Smith.

On paper, the stock looks good value at 17 times earnings and carrying a 3.5% dividend yield. But shareholders should buckle up for a potentially bumpy ride this week.

I’ll see what management says tomorrow before deciding what to do, if anything.

The post 25% tariffs! Where next for the Diageo share price? appeared first on The Motley Fool UK.

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Ben McPoland has positions in Diageo Plc. The Motley Fool UK has recommended Diageo Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.