Weak Pound, Strong Scotch

For an export-driven industry like Scotch where foreign shipments account for 90% of sales, a falling pound should be a source of joy. That's the theory, but is it true in practice? Ian Fraser investigates for WhiskyInvestDirect…

A recent article in the New York Times singled out Scotch whisky as one of the biggest beneficiaries of the pound's recent decline in value.

The US newspaper described the sharp falls precipitated by Liz Truss and Kwasi Kwarteng's disastrous "mini" budget on 23 September as having given the category an "extra boost" by "making whisky more affordable for buyers outside of Britain."

There is no doubt that the current weakness of sterling is a boon for some distillers – especially those with a big presence in the US and a focus on mass-market blends. Essentially without increasing their on-shelf prices, these brands can widen their margins, with their parent groups benefiting when US takings are converted into sterling.

However, it's not quite as rosy as the NYT seemed to imply.

Alan Hamilton, corporate-finance partner with accountants and business advisers Johnston Carmichael, says: "A weaker pound will accelerate demand slightly but the flip-side is rising costs when buying key supply components from overseas, on top of inflationary pressure at home. It's hard to see how a more favourable exchange rate will offset those."

Leonard Russell, managing director of Ian Macleod Distillers certainly doesn't see weaker sterling as a panacea. He recently told BBC Radio Scotland that: "The low value of the pound is going to help exports and will help us absorb some of the very large cost-inflationary pressures we are about to suffer from, particularly energy."

However, Russell stressed that surging input costs, including energy, malted barley and salaries, meant the Tamdhu, Glengoyne and other Scotches that IMD exports will cost more to produce, something the weaker pound will at best "negate for some of our customers overseas".

Barclays beverages industry analyst Laurence Whyatt said on-shelf prices in export markets won't be falling in line with sterling's slide. "From a customer perspective [a weaker pound] makes little difference – the companies won't reprice based on the foreign-exchange rate, except in the event of substantial negative moves."

"What a weakening pound will do is increase the profitability of companies like Diageo. As I understand it, Diageo will likely hedge their transactional FX [foreign-exchange] exposure on a rolling 12-month basis. This gives them visibility for pricing negotiations at the start of the year."  In its 2022 annual report, Diageo, maker of America's top-selling Scotch whisky Johnnie Walker, said it had benefited from "favourable impacts from foreign exchange, mainly due to the strengthening of the US dollar."

The time-lag between distillation and sale also needs to be taken into account.

Martin Purves, associate director of Kelvin Cooperage, said. "You need to bear in mind that whisky companies are disconnected through maturation: the input costs for today's product came at least three years ago in 2019 or before, and the cost of more expensive inputs today will not flow through to the cost of goods until 2025 at the earliest."

Whisky companies use a range of approaches to mitigate their currency risk. "If they're buying materials from the same countries as they're exporting to, they can create a natural hedge," says Hamilton. "From a treasury management perspective, they can also agree to forward contracts - for example fixing the price paid for casks which they may not require for three or six months. That provides some certainty."

"Companies can also spread their currency risk by keeping accounts denominated in sterling, dollars and euros, and making fund transfers when exchange rates are most favourable," adds Hamilton, who says any size of firm can use foreign-exchange derivatives bought from high street banks to insure against currency swings. 

John Stirling, co-founder of the "field-to-bottle" distillery Arbikie, says small and medium-sized distillers generally only hedge a portion of their currency risk, such as when they have a particular exposure resulting from ordering large quantities of casks or bottles from overseas.

Stirling believes high energy prices and weaker sterling may drive positive change in the sector, leading to more sustainable practices and more resilient supply chains.

He reckons that a prolonged weakness in the pound might well encourage more and more distillers to procure more of their grain, glass and other raw materials locally, developing longer term relationships with local suppliers. "It could be a wake-up call for the industry to buy more locally, shorten supply-chains, support local farmers and reduce carbon footprints," he says.

Hamilton predicts weaker sterling may also persuade smaller distillers to club together to bulk-buy essential items such as casks in order to benefit from volume discounts.

He also predicted that a weaker pound could spur M&A in the sector, with overseas players exploiting a weaker pound to snap up smaller groups for less. "Lots of overseas buyers can be expected to see opportunistic or value acquisition opportunities," says Hamilton.

So, a weaker pound has the potential not only to benefit mass-market blended Scotches sold in many overseas markets, to marginally boost the profitability of their parent groups but also to reshape the wider industry.

 

 

The pound's 100-year slide

The pound has been in steady decline against the US dollar for the best part of a century. During World War One, when Britain still had an empire, the pound was removed from the gold standard, meaning it became free floating and was no longer linked to gold.

However, in 1925, chancellor Winston Churchill put the pound back onto the gold standard, fixing it at £1 to $4.8665. The move caused John Maynard Keynes to accuse Churchill of having "imprisoned industry in a golden cage". Exports immediately became less competitive, since it the pound was deemed to have been pegged at too high a value. The pound came off the gold standard again in 1931. 

During the Great Depression, the pound surged to a high point of $5.15 in January 1934 and continued to float until the beginning of World War Two, when it was fixed to the "Mighty Greenback" at $4.03-$4.04. Under Bretton Woods, sterling was initially pegged at $4.03 but a balance-of-payments crisis forced the Labour chancellor Stafford Cripps to devalue it by 30% to $2.80 in September 1949. On 19 November 1967, Harold Wilson's government devalued it further, to $2.40, with Wilson somewhat unconvincingly reassuring Brits that the "pound in the pocket" would be unaffected.

As a result of the October 1976 sterling crisis which required Britain to take out an IMF loan, the pound sank to a fresh low of $1.58. On "Black Wednesday" in September 1992, short-sellers forced John Major's government to remove the currency from the European Exchange Rate Mechanism – a structure designed to reduce currency volatility ahead of the euro's launch: sterling fell 4.3% that day, closing at $1.778. 

The pound traded at $1.50-$1.65 for the rest of the "Nice decade" of the 1990s. In recent times, the pound climbed to $2 in October 2007 before falling to $1.70 in June 2014, then plunging to $1.0327 following Kwarteng's mini-budget. Since Jeremy Hunt ditched the vast majority of his predecessor's controversial tax-cutting proposals, the pound has recovered some poise and is today worth $1.23 (which means an overall decline of 76% versus the dollar since 1934). 

Against the Japanese Yen, the pound fell from ¥705 in January 1975, to ¥272 in August 1990, before sinking further to ¥119 in December 2011, then climbing back to ¥167 today (so an overall fall of 76% since 1975). Against the Euro, the pound opened at €1.41 in January 1999 before peaking at €1.73 in October 2000 then plunging to €1.03 in December 2008. It rose to €1.43 in July 2015 but, since Brexit, has been trading at between €1.10 and €1.20. 

A consistently declining pound has sadly not been a boon to Britain's overall export performance.