Of all the forecasts made about the effect of a vote for Brexit, few featured an all-time high for the FTSE 100 index within 110 days, and a doubling of earnings in the following 12 months at some of London’s biggest listed companies.
But that is precisely what is playing out — mainly because of two much more widely-expected phenomena: a crash in the sterling exchange rate and a reassessment of prospects for the UK economy.
Once-struggling oil and mining groups, exporters with strong overseas earnings and companies in “defensive” industries more insulated from the British economic cycle, have become the big winners since June 23.
By contrast, housebuilders, property developers, banks, insurers and high street retailers — all exposed to UK domestic demand and steepening import costs — are braced for earnings downgrades.
In the space of three months, the earnings outlook for some of Britain’s best known companies — and the prospects for their shares — have been turned upside down.
“Brexit is having a big impact on corporates; there are not many one-off events that have such a strong gravitational pull on company earnings, stocks and shareholder value,” said Laith Khalaf, senior analyst at Hargreaves Lansdown.
Although other factors — such as a continuing recovery in the price of oil and other commodities, and further interest rate cuts — have also influenced investor calculations, one constant in the past quarter has been a weakening of sterling. Last week’s flash crash in the pound, to $1.18, days after prime minister Theresa May’s “hard Brexit” speech at the Conservative party conference, accelerated a process that began after the June referendum.
Its effect has been to amplify the improving prospects of companies with substantial overseas earnings.
As a result, Royal Dutch Shell’s earnings are now forecast to rise 132 per cent, year-on-year, over the next 12 months (or more when compared with trailing 12-month earnings), miner Fresnillo’s by 109 per cent, Hikma Pharmaceuticals’ by 72 per cent, GlaxoSmithKline’s by 28 per cent, Unilever’s by 24 per cent, AstraZeneca’s by 20 per cent and drinks maker Diageo’s by 19 per cent.
At the same time, the divide between these winners and the more UK-exposed losers has become increasingly apparent — not least in recent days, with companies such as low-cost airline easyJet, outsourcing group Mitie and retailer Sports Direct all warning that profits will fall because of economic uncertainty in Britain.
“There are clear winners and losers,” said Guy Ellison, head of UK equities at Investec Wealth & Investment. “For international companies, such as the tobacco, consumer goods names and pharma groups, weaker sterling is a big tailwind that will help earnings. The losers are the UK-focused stocks, such as the housebuilders and the general retailers.”
Among this latter group, analysts name builders and developers, such as Persimmon, Taylor Wimpey and Barratt Developments; retail groups, such as Marks and Spencer, Next and J Sainsbury; and financials, such as Barclays, Lloyds Banking Group and subprime lender Provident Financial, as facing pressure to shore up revenues and profits.
Some of the forecast earnings falls in the next 12 months are significant: 11.2 per cent at Provident Financial, 8 per cent at M&S, 3.5 per cent at Next, according to Bloomberg data. These groups are heavily UK focused — almost 100 per cent in Provident’s case.
Guy Foster, head of research at wealth manager Brewin Dolphin, suggests much of this is yet to be felt by the companies and their shareholders.
“The groups likely to take the biggest profit hits are those with 80 per cent or more exposure in the UK,” he said. “So far, the economic numbers have surprised everyone with their strength but that is probably not going to last. The fall in the pound will lead to a fall in retail sales and consumer demand.”
Some other UK groups, such as energy utility Centrica, are having their earnings downgraded due to other post-referendum developments.
Analysts now expect that Centrica’s earnings will fall 55 per cent over the next 12 months, Bloomberg says, mainly due to worries over political risks to UK energy suppliers, after Mrs May alluded to greater control over energy tariffs.
By contrast, the earnings of exporters and groups with earnings unaffected by the UK economy are being upgraded, as their dollar and foreign currency revenues are boosted by the drop in the pound. This boon for international groups explains why the multinational-heavy FTSE 100 index is outperforming the more domestic FTSE 250 benchmark. As the FTSE 100 hit its high of 7,129.83 on Tuesday, the FTSE 250 was still struggling after Mrs May’s “hard Brexit” speech.
Another Brexit factor widening this performance gap is lower bond yields. Since the Brexit vote, bond yields have been depressed further as worries about the economy have lifted demand for sovereign and corporate debt — and the market prices. Even though some bond yields have risen a little in the past week, they are still dwarfed by the dividend yield from shares in Royal Dutch Shell, at more than 6 per cent, and GlaxoSmithKline, at nearly 5 per cent.
This has prompted some equity investors to rotate into stocks with international exposure and high dividend yields.
“Around 40 per cent of all UK company dividends are dollar-denominated,” said Jonathan Barber, manager of Columbia Threadneedle’s UK Monthly Income Fund. “Therefore sterling’s recent depreciation will increase UK dividend growth from around zero to nearer 7 per cent over the next year.”
He has recently bought more Shell shares — already his fund’s largest holding — as the 6.9 per cent dividend yield they offer is twice that of the wider market.
However, some analysts warn that Brexit remains a risk to all UK companies’ earnings and dividends — including the multinational giants of the FTSE 100.
“Brexit is a wild card,” said Mislav Matejka, global equity strategist at JPMorgan. “The FTSE 100 and the UK is seen as a haven — a country with a relatively strong economy, stable political situation and strong democratic institutions. Brexit could upset this perception, which would be a negative for all UK corporates, earnings and the stock market.”
Clarification: The forecast drop of 55 per cent in the 12-month earnings of Centrica based on Bloomberg data includes superfluous adjustments for impairments and remeasurements in the prior period. The fall is just 4 per cent if figures are restated without these.