The ‘BREXIT delta’

We talked here before about the differential impact of BREXIT on UK share prices, but what about multiples? This week we’d like to look at how UK market multiples have changed in the last year – in absolute terms and against their European peers.  A few sectors stand out in particular…could this make them a target for domestic or overseas buyers?

No dramas?

We can’t really talk about BREXIT without mentioning Article 50, which now seems set to be ‘triggered’ in the last week of March. It will be a momentous moment, but at the same time such a well-trailed one that markets really shouldn’t react unless it comes with something new.

Meanwhile, we’re still not quite sure what we need to be worried about yet. Thus it’s perfectly understandable that  investors were more immediately concerned this week with the Fed’s rate rise and the lone hawk on the MPC at the Bank of England.  Further signs that this year will be different

FTSE 350 in $ and £So, whilst we can’t rule out a wobble when the trigger comes, there’s nothing to see yet. Indeed, what’s caught the eye in the last week has been the further highs of FTSE 350, helped along by bid activity. But still, as this chart reminds us – the FTSE 350 still isn’t wiping its face since BREXIT in dollar terms. So, we wondered, where does this leave market multiples? How are investors assessing UK plc’s prospects?

BREXIT in evidence?

To start this process, we looked at Enterprise Value to EBITDA multiples (EV/EBITDA) on a next twelve months (NTM) basis for European* non-financial companies with a market value over €200m. To begin with, we focused on UK* registered companies.

UK multiples

The first and most obvious point is that the UK non-financial multiple look flat year-on-year. This isn’t all that surprising in the light of the FTSE 350 in dollars above. Share prices and earnings expectations have adapted to sterling’s fall.  Flat is relatively positive in the context of BREXIT concerns this time last year. But it’s obviously not flat for everyone.

We should repeat at this point that not everything after BREXIT is about BREXIT.  Rising US interest rates make holding metal more expensive for holders of foreign currency and precious metal is less attractive if yield is available elsewhere – all of which is responsible for a good part of the fall in the Basic Resource multiple .  Companies across most sectors are dealing with digital and behavioural disruption to some extent – Retail and Media sectors more than most. Regulatory pressures are also prevalent – for example in gaming. But, we can’t get away from it, BREXIT looms large and sterling’s fall in particular seems to be driving the changes in the last year.

The industrial goods and services sector has seen its overall EV/EBITDA multiple rise by 0.9x –  1.6x if we filter out the mixed fortunes of Support Services. Other sectors with strong overseas sales – such as Technology and Oil & Gas – have at least maintained their market multiples. Meanwhile, the stand-out fall is in Retail, which is exposed to the double-sterling-whammy of higher import prices and the impact of inflation on consumers.

The fact that Food & Drug Retailers have seen their EV/EBITDA multiple fall by 0.8x in the last year – much less than the 2.8x fall for General Retailers underlines the inflationary point. The current thinking in the market is that supermarkets will be able to use this moment to finally pass price rises through much better than General Retailers – although this is by no means a certainty.

But how do these multiples stack up against European peers. Are investors really viewing UK and European companies differently? Our analysis suggests there is…

The ‘BREXIT Delta’

Eur vs Uk multiples

Across almost all sectors, UK company market multiples have fallen more – or grown less – than European* companies peers in the last year. On one level, investors could simply be following the growth – or at least the momentum. February’s PMI surveys show that UK economic growth may be losing pace, whilst the Eurozone is enjoying its best period since the sovereign debt crisis in 2011. Europe isn’t without political risk, but it’s largely theoretical at the moment and slightly diminished after the Dutch election result.

But the data shows that this isn’t a blanket move. There is a strong sector differential and the three UK sectors that are  just about holding their own all have  high overseas sales exposure and/or defensive qualities. Actually, if we take Support Services out of Industrial Goods and Services, its EV/EBITDA multiple has moved 0.6x higher in the last year than the European equivalent. UK Support Services  is 0.2x lower – a measure of its troubled year – or years. Conversely, Retail stands out again as a significant loser against its European peers. The consumer is expected to come under greater pressure across the whole of Europe in 2017; but the UK is clearly being valued as a special case – and not just in Retail, but other consumer facing-sectors.

Thus, it seems as if there is a ‘BREXIT delta’ in evidence– but as yet primarily focused on the impact of a weak pound, especially on the consumer. But, what about trade? Not just in relation to BREXIT, but world-wide moves towards protectionism. Multiples aren’t  indicating any special concern and the STOXX exposure indices underline this point. Until the start of 2016, domestic sales weren’t a differentiator for UK companies.  But, since BREXIT, a having a higher proportion of non-UK sales has clearly been regarded as an advantage for now familiar reasons– access to stronger currencies, faster growing markets etc. This is clearly outweighing any trade risk for now.

UK exposure

Deals

As is the nature of uncertain times, investor views on a sector often move on mass. There will be companies that are undervalued in unloved sectors and business that are overvalued in admired ones.  There will be chinks in valuation and attractive targets  – and not just because of sterling’s fall.

Actually, if you look at deals so far in 2017, most bidders have been domestic. Yes, the weak pound makes assets cheaper for overseas buyers, but you don’t buy a house you don’t like because its price has fallen by 15%.  You might, however, reconsider a house you’ve been admiring for a while if the price falls – and you might make an offer – subject to searches and survey. UK valuations are looking more attractive that European peers in many areas, but buyers still need to want their products and markets and will need to take a view on areas like the consumer, trade and labour in the coming years and that’s tricky at the moment. The composition of a company’s board and shareholder base will also play a part – as will increasingly politics as the Kraft bid for Unilever illustrated.

So it could take a brave investor to bid for some UK assets– but bold was one our themes of the year given that companies still need to meet the challenge of low growth, disruptive forces and changing behaviours. We expect to see more bold moves in 2017.

Notes:

 *UK = includes Channel Islands and Isle of Man

 *Europe = EU and EEA (ex-UK) & Switzerland


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