Brexit And My Diageo Purchase: Plan A Has Collapsed, But Plan B Remains In Progress

| About: Diageo plc (DEO)

Summary

The UK has voted for Brexit, but the country remains overwhelmingly split in many ways.

Volatility seems certain as we currently sit in a period of intensely "uncertain uncertainty".

Despite the currency and UK market falls, my recent DEO purchase remains on track even after Plan A was derailed by Brexit.

Well, that was not what I had hoped we would come out with. The UK has voted by 51.9% to 48.1% to leave the European Union. Despite fears this would occur, I had hoped that the opposite would be true. Since then, the Prime Minister has announced he is to stand down as a result, and the opposition Labour Party seem to be hankering after their own leader's head.

Already, however, the closeness of the vote as well as the dramatic nature of its outcome has led to rumblings of another referendum being called on the issue. At the time of writing, nearly 3.2 million have petitioned for this to be the case (bear in mind 16.1 million people voted to remain).

Will it happen? I don't know. There are plenty of reasons to think not. Yet to close the door on it as a possibility is equally presumptuous. Previous referendums on EU matters in Denmark and Ireland (in fact, two there) have gone to a second vote in which it has, in fact, passed.

Also, many voters who voted "Leave" as a protest vote against the government (and, in some cases, the Labour Party) are coming to a realization of their error. Traditionally, in the UK, the local council elections (the democratic level below electing Members of Parliament) have served as prime vehicles for protest voting. The idea was to give the government a bloody nose.

Usually this works, the number of seats held in local government by the incumbent government usually changes noticeably but the bigger warning is usually the dropping total voting share held by the party. It is a protest vote, which generally, serves as a reminder to government rather than a revolution in government. Rather than giving the government a bloody nose in the referendum, however, some are realizing they have rather cut off their nose to spite their face. Public opinion may, therefore, shift enough for a fresh referendum to perhaps even be necessary.

A Deeper Split Story

What is true is that the vote has split the country even more than the near 50/50 split suggests. Scotland and London all voted clearly to remain. Already talk has turned to potential independence votes for both (though, naturally, the Scottish vote seems much more likely than the London one). In Northern Ireland, which also modestly voted to remain, talk of reunification with the rest of Ireland has reemerged.

Worrying enough, maybe. Yet the generations are also pitching against one another. The younger generations were shown to be massively in favor of the EU compared to older generations:

Needless to say if you were to break down the massive 25 to 49 age group (which could encompass both parents and their children) further, you would likely see a split between the younger and older extremes of that cohort.

I sit in the younger part of that cohort, and I can say that the proportion around my age is much higher in my experience. I was only about 6 years old when the Maastricht Treaty brought the EU to life. I am, therefore, in essence an "EU native." As an "EU Native" British citizen, I find it as hard to consider myself "British" yet not "European" as I would to consider myself "English" yet not "British" (a possibility raised by the potential Scottish independence move).

I'll be frank, I am worried by this outcome. Brexit has made the divisions in the UK much more apparent. Yet for me, the most worrying is the generational one. Animosity between the older and younger generations has been particularly heated for years. Pensions, property prices, job security. All have pitched the younger generation against the older with the high likelihood that the younger generation today (for the first time in 150 years or more) will be less well-off than the older.

Brexit has really sharpened this divide right now. Many younger members of society feel spirited out of Europe by a generation, which had benefited economically and socially from their membership of it. This, just at the time when the social, economic and political authority of this younger generation is beginning to replace that of the "baby boomer" generation. Such heightened animosity is unhelpful, if presently inevitable. The vitriolic war of words between the two at the moment is, for me, the most unappetising aspects of the current debate.

Despite this, it is not the "end of worlds." The UK will, likely, do as well outside the EU from an economic perspective as it did inside it (eventually, at least). Generational animosity around this issue will hopefully dilute even if it is unlikely to entirely disappear.

Brexit and my Diageo Purchase

Now we come to an investing-specific to the Brexit vote. My actual portfolio saw some fairly hefty falls in my UK-only holdings:

Fortunately, amongst my top 5 holdings (red above), which make up over 40% of my total portfolio value, three saw strong positive share prices on the day. Generally speaking, my portfolio evolution in recent years towards more defensive investments in highly cash-generative, balance sheet healthy businesses with strong economic moats served it well. This is especially true as many are very much international operations who may well benefit from the weaker GBP (for instance, Burberry (OTCPK:BURBY) and Spectris (OTCPK:SEPJY)).

Nonetheless, all was not perfect! Some of my financial holdings such as Legal & General (OTCPK:LGGNY), Schroders (OTC:SHNWY), and Banco Santander (NYSE:SAN) did take a bigger hit (the word "plummet," in this context, would be fair).

Courtesy of the sharp fall ("plummet" fair again here) of the GBP against the USD, I also saw my US investments despite their share price fall appreciate nicely in GBP.

However, some may remember that within my more conservative corner of my portfolio I did take on a little additional Brexit-related risk. Indeed, at the height of the pre-referendum belief that the UK may leave the EU, I picked up some NYSE-listed Diageo (NYSE:DEO) shares. Consequently, I exposed myself to the additional currency risk inherent in these shares.

The reason? Quite simply it was both to play the depressed Diageo share price of the underlying London-listed Diageo shares (I also picked up more of the London-listed DGE shares) which had already been exaggerated by the pre-referendum GBP weakness. My logic was that, should the "Remain" camp win, then the GBP should strengthen providing a nice boost to DEO's share price.

Up to the vote, it was panning out well. Diageo's underlying London-listed share price had lifted modestly and the strength of the GBP had lifted the DEO shares even more so. However, this was fed by the belief that Brexit was becoming an increasingly unlikely outcome.

Transparently, this was very wrong.

Consequently, the GBP has weakened even further after reaching a peak of $1.50 just as the polls closed it fell to just $1.34 by early 24 June (a fall of nearly 11%). Eventually, it settled the day at just under $1.37 (about 8.7% down).

Still Going Well?

Not great for my DEO play, it must be said, leaving me with a near 9% currency headwind. But this is not quite true. First, when I had bought the DEO shares (at the height of the pre-referendum belief in Brexit's chances), the rate was $1.42 meaning my actual purchase only faces a 3.5% headwind at present.

Nonetheless, surely the share price dropped too? This is what I had assumed at the time:

Should Brexit occur, however, I suspect the GBP will weaken sharply and the FTSE 100 (as well as Diageo's London-listed shares) will follow suit.

Well, currency-wise this was a sound assessment as was my view on the behavior of the FTSE 100 (UKX) which dropped (admittedly a fairly modest) 3% by the end of 24 June:

Yet, Diageo's London-listed shares proved me wrong on the third belief. Far from dropping, they lifted 3.8% from £18.33 to 19.03 per share. Diageo's defensive, global nature has insulated it from the worst excesses of the market swings on the day. Indeed, Diageo's home currency being the GBP and seeing as most of its revenue comes from outside the UK, the weaker GBP should help reported results in the immediate term.

This is perhaps a reminder of exactly why Diageo was the target of my more "risky" currency play. A reminder of why I was willing to take on this "out of character" extra risk. As I noted at the time:

Fortunately, the way I have structured this "short-term" play, is quite deliberate. Should it "go bad" and my short-term investment melds into a long-term one, I am pleased to think that even a "bad" investment outcome would leave me with a healthy consumer defensive company with a 3%+ dividend yield.

Right now, I am not needing to console myself with the knowledge of the company's quality. Other investors' recognition of this fact has also kept me ahead of my purchase price. So far, I am still showing a 6%+ gain in GBP. In USD, it is a more modest 2.3% gain. Yet it remains a gain with a still superb company with a great yield.

The Future

So far, the DEO share Diageo purchase is still going fine. Despite what can only be described as a hostile looking backdrop, I remain in the black. More volatility is certain. Whether this would see this current gain wiped out, though, is still very unclear.

Interestingly though (looking back at the above chart), the FTSE 100 still remains above the position it was at back in mid-June around my purchase date (15 June). It may be, therefore, that the UK stock market may well fall further. Chiefly this is because I can't help but think that the actually fairly soft market falls (though unwelcome) reflect a certain degree of what seems to be uncertain uncertainty. Investors are so uncertain about what is uncertain, they may have ended up pretty much standing pat.

Will the referendum be re-run with an opposite result (plausible based on history and present sentiment)? Will the government ignore the referendum results (possible though unlikely even now)? Will the UK and EU agree to retain the single market and passporting set-up currently in place despite the UK being "out" of the EU itself (quite possibly)? All are potentials. Yet as these uncertain uncertainties become more certain, the market will respond. Now it is hard to gauge whether the reaction will be positive or negative. For this we will need to wait.

With regards to my DEO purchase. Right now, clearly the "ideal" Plan A has unraveled. Yet Plan B remains securely in place and working well. Diageo remains a defensive company with added attractions in the current volatile and uncertain economic backdrop. Despite laboring against tough currency conditions, the underlying company's qualities have kept my investment on a sound footing.

Despite everything, I remain comfortable with my portfolio at the moment. It has held up well including my recent "riskier" DEO buy.

My discomfort right now is where my country is positioned for the immediate future. Here again, Plan A (the presumed "Remain" win) has failed. Plan B, however, has yet to emerge with any clarity.

All we can do here is wait to see how things evolve. It is going to be an interesting ride. All I do know is people will keep drinking Diageo's products (indeed, maybe just that little bit more) in the meantime.

Notes

Unless otherwise stated, all graphs and the calculations contained within were produced by the author. Creative Commons images reproduced from Flickr users 141776778@N02 (polling card) and mustafakhayat (Smirnoff).

Disclosure: I am/we are long DEO, BURBY, SEPJY, LGGNY, SHNWY, SAN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.