UK stocks that benefit from a weaker pound
The UK’s decision to leave the European Union has caused the devaluation of the pound against other major currencies. We have a look at what this means for UK businesses and the stocks that benefit from weaker sterling.
Brexit is yet to happen, and we still don’t know the true extent of the impact it will have on the economy and businesses. However, the depreciation of the pound – which, after the referendum, reached near-parity with the euro and a fresh 30-year low against the dollar – is a clear and immediate consequence of the UK’s decision to leave the EU.
Sterling still trailing up to 10% against major currencies since the Brexit vote
|24 June 2016||1.368||1.23||139.85||1.779||1.833|
|23 June 2017||1.272||1.136||141.54||1.687||1.6803|
|25 June 2018||1.327||1.134||145.75||1.765||1.79|
|24 June 2019||1.274||1.117||136.72||1.679||1.83|
|4 October 2019||1.232||1.123||131.88||1.64||1.832|
How does a weaker pound impact UK businesses?
The effect of a weaker pound on UK businesses has been well covered. For UK companies getting their hands on the materials they need from overseas has become more expensive. For those that export their products abroad, the knock to the currency is seen as beneficial because UK-made goods are more competitive and cheaper for foreigners to buy. Additionally, exporters can leverage a weaker pound by cutting their prices even further, allowing them to steal greater market share from international rivals.
But it is more complex than just identifying importers and exporters
However, current discussion about the devaluation of sterling risks simplifying what is a far more complex issue. It is not enough to say that UK-based companies that export are beneficiaries and those that import materials are not.
For starters, supply chains are far more complex. Take the UK automotive industry as an example. Over 80% of cars made in the UK are exported, which suggests carmakers should be enjoying the state of sterling. But this is not the case, because they import over half of the parts they need from other countries, which has increased their costs.
How to analyse the impact of a weaker pound on stocks
There are several points to consider if you are to truly understand how a company will be impacted by a weaker pound, including:
- What currency does the stock report in? If a stock reports in sterling but generates sales in another currency, like the US dollar, then revenue and earnings should be boosted when they are translated back into the pound.
- What currency does the stock use to buy goods? When the pound is weak, it is better to buy more UK-produced goods to avoid having to pay more for foreign materials.
- What currency is the stock’s revenue in? Equally, it is better to generate sales overseas when the pound is weak to benefit from the translational effect.
- What currency are the stock’s assets, debt and cash reserves denominated in? Weaker sterling can cause debt denominated in other currencies to rise. This would influence important ratios, such as debt to earnings, especially if earnings are generated in sterling. Similarly, if it has large cash reserves of, say, dollars, then this protects its buying power while a large amount of sterling cash hoarded away will lose its value if the pound weakens.
- What currency is used by the stock to pay dividends? For investors, it is vitally important to understand how a fall in sterling will impact their dividend payments. If dividends are paid in euros or dollars, then this should benefit the investor once payments are converted into sterling. However, sterling-denominated dividends will be worth less to foreign investors when they are translated into local currencies.
- What currency hedging strategies are in place? The company’s response is often ignored when evaluating the impact of a weaker pound. The majority of larger stocks tend to hedge their bets to mitigate any effect of currency fluctuations, which shields them from any negative effects, but also prevents them from benefiting from a weaker pound. The reality is that many of the biggest firms that can benefit from the pound’s depreciation don’t because they have hedging strategies in place. With this in mind, currency fluctuations tend to have more influence on small to mid-cap firms rather than blue-chip stocks. Plus, the longer companies have had to become accustomed to a weaker pound, the more likely they are to introduce measures to mitigate the threat.
The weak pound and the relationship between the FTSE 100 and FTSE 250
One theory that has been repeatedly mentioned is that a weaker pound is better for the FTSE 100 than the FTSE 250. This is based on the assumption that companies in the FTSE 100 are larger and more internationally-diverse, and therefore set to benefit when their earnings are translated into pounds. Meanwhile, the FTSE 250 contains more domestic market-focused stocks that will feel the impact of a weaker currency over the longer term.
This assumption is too general. Indeed, if this relationship was true then the mid-cap index would have significantly underperformed its blue-chip counterpart. In reality, the FTSE 250 is up more than 24% since the referendum, compared to the 21% increase reported by the FTSE 100.
It is true that more mid-cap stocks are generally more exposed to a weaker pound than blue-chip stocks. Yet you can’t tarnish all FTSE 250 members with the same brush and assume a weak pound will have the same effect on every constituent. There are plenty of mid-cap stocks that are in a position to benefit from a weaker pound, especially those operating in resilient sectors such as healthcare or industrials.
GlaxoSmithKline (GSK) is a global pharmaceutical giant that operates around the world, but reports in sterling (unlike its peers AstraZeneca or Hikma). The company’s results have been mildly impacted by fluctuations in the pound, particularly versus the dollar. GSK has said the weakness in sterling could boost revenue by 2% in 2019 while adjusted earnings per share (EPS) could benefit by 4%.
Diageo, the alcoholic drinks giant, reports in sterling, but generates the majority of its sales in other countries, meaning it is well positioned to benefit when revenue and earnings are translated back into pounds. The company reported minor gains from exchange rates in its recently ended financial year to the end of June 2019, which was principally driven by sterling’s weakness against the dollar, the euro, and the Kenyan shilling.
The company has said that it should continue to benefit in the new financial year. Based on assumptions that the pound will average $1.25 and €1.11 (close to the current levels, but weaker than the average seen in the 2019 financial year), Diageo expects to report a £375 million boost to net sales in the year to June 30, 2020, while operating profit would benefit by £135 million.
British American Tobacco
British American Tobacco (BAT) is one of the most geographically-diverse businesses in the world and sells cigarettes globally. The UK is a relatively minor market for the company in the grand scheme of things – 38% of revenue comes from the US, 20% from Asia and the Middle East and 18% from the Americas and Sub-Saharan Africa. That leaves 24% from Europe and North Africa, and the UK will only account for a fraction of that. However, the UK is crucially important for its vaping business, which is where tobacco companies are finding growth amid the fall in smoking rates.
In 2017, when BAT’s average exchange rate fell to $1.301 from $1.344 the year before, revenue jumped 4.3% year-on-year (YoY). That was largely thanks to the weaker pound as the increase was just 0.2% at constant-exchange rates. Similarly, when sterling strengthened to $1.330 in 2018, revenue fell 1.8% but would have risen 5.7% at constant currency.
AB Foods is another company that largely benefits from a weaker pound, with over 60% of its operating profit earned outside the UK but exchanged into sterling. It said a 10% rise in sterling against the dollar and the euro would have knocked £14 million and £31 million off its 2018 annual profit, respectively.
The company, which has a unique business built around ingredients and clothing, says British Sugar is particularly sensitive to the GBP/EUR exchange rate. Notably, clothing store Primark predominantly buys in dollars and sells to customers with euros, and has been benefiting from relative weakness in EUR/USD over the past 18 months.
Rotork, which makes actuators and flow control systems, benefits when the pound’s value falls against the dollar and the euro. It said the average GBP/USD exchange rate in 2018 was four cents stronger than the year before and that this knocked over £16 million – or 2% - off revenue for the year, demonstrating how fairly mild movements can have a big impact. It added that the euro strengthening against sterling by one cent would boost profit by £400,000, based on its 2018 results, while a one cent increase in the dollar would provide a £600,000 increase.
Renishaw, which specialises in precision measurement technology used in everything from agriculture to healthcare, reports in sterling but generates 96% of its revenue overseas. This exposes it to movements between the sterling and the US dollar, the euro and the Japanese yen. It booked sizeable gains in the recently ended financial year (to the end of June 2019) thanks to the depreciation of sterling against the US dollar. The company said its pre-tax profit would have been £300,000 lower if the pound had been 5% stronger.
Victrex, known for producing polymers used in a wide variety of high-end applications, is one of those companies that imports materials to make goods in the UK and then exports the majority of it to overseas customers. The majority of its cost base is in sterling, but 98% of its revenue is generated outside the UK – with up to 60% coming from Europe. It is mostly exposed to sterling’s relationship with the US dollar, the euro and the Japanese yen.
The company has said that, if the pound loses further value following a no-deal Brexit as expected, then this may help mitigate the introduction of tariffs on both imports and exports during the first year of trade between the UK and the EU. It said, assuming the pound weakens by a further 10% under such a scenario, this could ‘provide a high degree of mitigation’ against the threat of tariffs.
The company has something of a monopoly as it is the only producer of PEEK polymers - a material with high levels of mechanical and chemical resistance - in the whole of Europe. Therefore, many of its European customers will have little choice but to keep buying from the UK-based business regardless of Brexit.
This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
Explore the markets with our free course
Discover the range of markets you can spread bet on - and learn how they work - with IG Academy's online course.
Turn knowledge into success
Practice makes perfect. Take what you’ve learned in this shares strategy article, and try it out risk-free in your demo account.
Ready to trade shares?
Put the lessons in this article to use in a live account. Upgrading is quick and simple.
- Trade over 12,000 popular global stocks
- Protect your capital with risk management tools
- Deal on 70 key US stocks out-of-hours, so you can react to news
Inspired to trade?
Put the knowledge you’ve gained from this article into practice. Log in to your account now.
You might be interested in…
Find out what charges your trades could incur with our transparent fee structure.
Discover why so many clients choose us, and what makes us a world-leading provider of spread betting and CFDs.
Stay on top of upcoming market-moving events with our customisable economic calendar.