Since the United Kingdom voted in June 2016 to leave the European Union, concerns over Brexit have buffeted the share prices of Australian companies. As the result of the Brexit vote was announced, the ASX was one of the few world markets that was open and trading at the time when news of the vote came through. On that Friday over three years ago, A$42 billion was wiped off the market capitalisation of the ASX in a day that ruined the lunch of many fund managers and stockbrokers.
Most Australian investors would find the political machinations somewhat bewildering – both internally within the UK and in the UK’s attempts to thrash out a deal with Brussels. Both the prospects and the conditions contained in the Brexit deal are changing daily in the lead up to the Halloween 31st October deadline.
As we strongly believe that no expert has the answers as to what the Brexit political settlement will look like, in this week’s piece we are going to consider the impact in Australia of previous major world political shifts, and examine the actual profits earned by ASX 200 companies in the United Kingdom and the quantum that might actually be at risk.
While fear and uncertainty have dominated the animal spirits of the market it is hard to make the case that Brexit will trigger another GFC for Australian equities, nor indeed that a recession in the United Kingdom will have a dramatic impact on the profits of Australian listed companies.
Previous major changes
While a hard Brexit will harm the UK economy, we don’t see that it necessarily represents a doomsday scenario. In our opinion the impact will likely be closer to that of Britain’s withdrawal from the European Exchange Rate Mechanism (ERM) in 1992, which fixed the GBP against the European Currency Unit (ECU), the precursor to the Euro. In September 1992 the GBP initially fell against the Deutsche Mark and USD along with the FTSE 100 index. Despite tough talk at the time there was ultimately little impact on UK’s trade with the EU. Additionally, big export-orientated companies such as Diageo, Rolls-Royce, British American Tobacco and Unilever saw solid profit and sales growth in 1993 from a falling GBP. The ASX200 gained 34% in the year following Britain’s withdrawal from the ERM, though this was driven by domestic banks recovering from a property collapse in 1991, rather than positive influences from Europe.
Australian Profits coming from the UK
In the 2019 financial year the 200 companies that comprise the ASX 200 delivered a net operating profit after tax of A$107 billion. Of this, A$3 billion or 2.8% was derived from companies with operations in the UK, or companies that export goods to the UK.
The below table looks at the top 20 companies in the ASX 200 exposed to the UK, ranked by their UK sourced profits. These companies may face a hit on the translation of the A$3 billion profit sourced from the UK if the GBP falls further in the back end of 2019. However, after weakening in 2016 and 2017 following the vote, the GBP is now trading at A$1.85 which is very close to the level at which it traded before the Brexit vote in June 2016.
In the final column of the table we have looked at the goods and services supplied to the UK by these companies and the potential impact that a hard Brexit could have on demand. We see that it is difficult to make the case that all of the profits that Australian companies earn in the UK, or even the majority of this profit, is actually at risk.
Very helpful piece Hugh.