20 Aug 2019
With Boris Johnson confirmed as the new prime minister we’ve had a look at some of the areas of the market that could benefit from regime change. In some cases we see a continuation of existing trends, but in other cases we think there is the potential for a reversal of recent fortunes. In particular we’d highlight our view on international earners, public sector outsourcers and the “sin sectors”.
Boris Johnson’s key pledge has clearly been to take the UK out of the European Union by 31 October 2019. Whether or not he is able to renegotiate Theresa May’s deal remains to be seen, but sterling has weakened modestly since Johnson emerged as the front runner in the race to become prime minister.
The playbook on Brexit to date has been to own UK-listed foreign-earners that have benefited from their international sales being translated back into sterling at a weaker exchange rate, and in some cases have also benefited from the mismatch between USD/EUR denominated revenues and GBP denominated costs—leading to margin expansion. The other side of this trade has been to avoid UK domestics, particularly those that rely on importing what they sell, such as UK retailers.
The impact of the international vs. domestic earners trade is illustrated by the performance of the FTSE All-Share Index (the orange line on the chart) compared to the FTSE “Local” Index (the blue line), which constitutes UK-listed companies that derive more than 70% of their revenues from the UK.
Should the UK head towards a hard Brexit then this strategy could continue to pay off. That said, with the valuations of UK domestics under continued pressure and the potential for some level of fiscal stimulus it could be sensible to retain exposure to certain domestic areas, such as house builders, which trade on a price-to earnings ratio of around 8x, are largely debt free and could benefit from any potential stamp duty overhaul.
Since 2009 investors have been rewarded for avoiding businesses with high exposure to government spending. The government’s drive to extract more value at a lower price has left a number of high profile casualties in the UK-listed market. Outsourcers found themselves bidding over lower prices for ever more complex contracts. Construction contractors followed a similar trend and defence spending hasn’t grown enough to generate much by way of growth for that sector at a time where the rest of the global economy has been roaring away.
Yet in an economic cycle that’s long in the tooth there could now be some attractions in businesses with less cyclical, government-backed earnings—particularly if the government is willing to spend more, not less. During his leadership campaign Boris Johnson made significant spending pledges and this could indicate a turning point for businesses that count the UK government as one of their most important customers.
In recent years investing in businesses perceived to be “socially bad” has exposed investors to the risk of overnight shocks. Whether it was beverage companies and the sugar tax, gambling companies and the reduction in fixed odds betting terminal stake limits, or tobacco, high cost credit or even funeral prices the government has been increasingly interventionist in markets.
Under Theresa May, the vicar’s daughter, investors have needed to tread carefully in these sorts of sectors for fear of such shocks. Under Boris Johnson could things be different?
The new prime minister has already said that he’d look to scrap the sugar tax to arrest the “creep of the nanny state”. There may be a case to read this logic through to some other areas of the UK market that have suffered from perceived regulatory risks.
The most obvious potential beneficiary of a U-turn in the social agenda would be the UK bookmakers, which have almost halved in the past 18 months and have materially underperformed the broader market.
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