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Brexit-proof shares

How investors can shelter from the turbulence
June 30, 2017

Harold Macmillan epitomised the difficult relationship with Europe that has overtaken our national politics. The Conservative prime minister from 1957 to 1963 had to respond to the creation of the European Coal and Steel Community (ECSC) - the forerunner to the European Union - set up following World War II by West Germany, France, Italy, Belgium, the Netherlands and Luxembourg.

Faced by this group, which he and others called 'Little Europe', Macmillan's early - and frustrated - effort was to propose a free trade area in Europe, excluding agricultural products, to soften the impact of the ECSC's common market on UK trade. "If Little Europe is formed without a parallel development of a Free Trade Area we shall have to reconsider the whole of our political and economic attitude towards Europe," he wrote in a 1958 minute, republished in Peter Hennessey's classic 2000 book on postwar premiers, The Prime Minister: The Office And Its Holders Since 1945.

He went on: "We should certainly put on high protective tariffs and quotas to counteract what Little Europe was doing to us… We would take our troops out of Europe. We would withdraw from Nato. We would adopt a policy of isolationism."

A free-trade agreement involving the countries of the single market was vetoed by Macmillan's ally and nemesis Charles de Gaulle. The French president went on to veto UK accession to the European Economic Community in 1963, with his famous "non", much to Macmillan's surprise and disappointment; and again in 1967 when Harold Wilson was on the other side of the table.

Half a century on from that angry note, and seeking an 'out' this time, the UK government is again using a combination of threats and shared interests to strike a free-trade deal - once matters including the UK's exit settlement, citizen's rights and the status of Northern Ireland are settled.

It is debatable whether the task is easier this time around. June's snap election makes the UK's negotiating position less stable. If the Conservatives' minority government founders, another election is likely. Commentators thought the poor result for incumbent Theresa May would embolden those prioritising jobs and trade over immigration control, and the tone of the government has moderated - chancellor Philip Hammond has described "a Brexit deal which puts jobs and prosperity first" - but it is hard to tell how this will feed through to the negotiations.

Beyond the polarised discussion of 'hard' and 'soft' Brexit, there are many options for a future UK-EU relationship (see the final page of this feature). But it is near impossible for private investors to predict what deal, if any, will come out of the negotiating window. Given turbulence is likely for companies that are heavily exposed to cross-channel trade and the domestic economy - and there were signs of economic stagnation even before last year's referendum - it is a good time to consider those stocks that can glide above it. Here is our pitch at a 'Brexit-proof' portfolio.

 

 

 

How we picked them

In order to to come up with a list of companies that are better insulated from a disruptive Brexit, we have used objective data from Capital IQ, supplemented by our own judgment.

It is difficult for the private investor to avoid the effects of currency movements entirely. Those US dollar-denominated stocks that have benefited from sterling's weakness could be pulled back to earth if the UK currency strengthens through the negotiating period.

Nevertheless, we have sought in our screen those companies that generate non-sterling revenues, and mostly report in other currencies, too. The theory being that these companies will be better protected from economic disruption localised to the UK-EU trading relationship, and will have less of a currency headache in the event of further sterling volatility.

This has thrown up an interesting mix of globally focused stocks, including the commodity majors for which London has been a long-term home, as well as some of the niche, domestically incorporated companies that target big markets such as the US.

In order to make sure we get a broad enough range of companies, we've sought to avoid companies with a UK segment in their corporate reporting, but have not discounted those that might have a small proportion of domestic revenue.

We have excluded any stock currently rated a 'sell' by this title, most are 'buys'; that's partly where the subjectivity comes in. And there are plenty more options in the table below, which presents the performance, yield and valuations of those companies with the largest proportions of overseas revenue (data courtesy of broker Liberum). Here are 10 from a range of sectors.

 

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Beazley (BEZ)

Investors would be forgiven for avoiding the City of London altogether, but that might be to miss a trick. Lloyd's of London is a global market, for which Europe (including UK) only accounts for 29 per cent of gross written premiums. The institution is managing the market's Brexit risk by opening a Brussels office, but it is also expanding in other areas: its platforms in Shanghai and Beijing are building up their number of managing agents, and it has established a reinsurance base in India.

The major market for Lloyd's syndicates is North America, which accounts for half of gross premiums. Beazley embodies this international focus. Less than 5 per cent of its business is generated within mainland Europe, and the Brexit vote has simply encouraged previously held plans to develop its Dublin office. Having built up its US platform over more than a decade, the insurer has managed to grow its premiums in a low-rate market by focusing on small-scale risks. Its cyber insurance specialism is pushing on an open door.

The combined ratio (the proportion of income eaten away by claims and expenses) remains in line with the long-term average at a healthy 89 per cent. Buy.

Last IC View: Buy, 438p, 7 February 2017

 

BHP Billiton (BLT)

London's largest diversified miner certainly has its challenges, but Brexit isn't high up there. BHP is still dealing with the fallout of the 2015 Samarco disaster; the outlook for its commodities is as ever uncertain, and it is now under pressure from activist investor Elliott Management.

But as we argued in our recent tip (Buy, 1,171p, 25 May 2017), private investors could benefit from jumping on Elliott's back. Management has already responded to its intervention with its own plan to improve shareholder value, and the timing couldn't be better: given projections of $15bn in cash flow to come from operations in each of the next three years, investors' claim on that cash looks good, and value-destructive acquisitions are unlikely.

We include BHP in this group for its spread - its biggest assets by value lie half a world away in Australia, followed by North America and South America, and it sells in dollars. When it comes to turnover, only $1.2bn of its $30.9bn revenue last year was attributed to Europe. Its annual report does accept that Brexit poses a threat to its eurozone market, but the share price responds to demand coming from further to the east.

Last IC View: Buy, 1,171p, 25 May 2017

 

Centamin (CEY)

"Buy gold" has become a common sarcastic refrain for the latest unexpected - or unliked - political development in these fast-changing times. But there could be a good case for buying a gold miner if you are looking for a bit of protection from UK political turbulence.

We think that goes for Centamin in particular. Yes, the price of the yellow stuff has not managed to maintain the highs that we saw in the turbulent middle of 2016, but there are other potential sources of volatility - the current Qatar crisis being a good example - that could contribute. Still, as we wrote in last year's cover feature ('Solid gold', 17 June 2016), there are good reasons to believe that gold's long-term value will hold up, including that central banks are buying more of it, led by Russia and China.

Against that backdrop, Centamin - solely focused on the Sukari gold mine in Egypt - is lowly valued against peers and has an emerging habit of beating earnings guidance. And last year's special dividend could yet be repeated.

Last IC View: Buy 117p, 16 February 2017

 

 

Craneware (AIM:CRW)

This company provides software and services to the US healthcare industry. Yes, that means a nice dollar boost since the referendum result, but it also means Craneware is fairly well insulated from any tortuous separation of the UK from the EU.

Instead, the relevant structural change is the reform of the US healthcare system, which was front and centre in last year's presidential election campaign. While pricing pressure for drugs has been heightened for the pharma majors (listen to our recent special podcast on that subject), Craneware should continue to benefit as providers look to improve their efficiency: one application of its tools allows US clinics and hospitals to delve into patients' clinical history to find the most cost-effective treatment.

The company saw a boost in sales following the election, and has very good revenue visibility and cash flows. The company is expensive at 35 times this year's earnings, falling to 31 times next year, so investors could be forgiven for wanting a better point of entry. But earnings upgrades may help soothe the vertigo.

Last IC View: Buy, 1,200p, 7 March 2017

 

Elementis (ELM)

Dollar-earning and globally orientated chemical stocks present a good defensive story for investors concerned that Brexit will make things tricky for UK plc. Elementis' own risk assessment provides further grounds for confidence, with management saying that Brexit does not materially change the principal risks faced by the group. UK sales of $21m are just a slice of the $660m total.

Given that Elementis also makes a good amount of its chemicals in the US, and sells them around the world, it actually suffers from dollar strength relative to its selling currencies. The resultant margin squeeze has not been its only challenge in recent times, with the oil downturn suppressing demand for its speciality chemicals.

Chromium prices are up, and the addressable automotive market is expected to reach $2.5bn by 2025, as we set out in our recent tip (Buy, 293p, 20 April 2017). We think this earnings rebound continues to provide an opportunity, to which Messrs Davis and Barnier do not pose much of a threat.

 

NMC Health (NMC)

There are many stocks in the pharmaceuticals and healthcare sector that could sit well in this list. AstraZeneca (AZN) and Shire (SHP) are both live IC buy tips whose fates are determined in the offices of the US regulators and policymakers, rather than the corridors of Brussels.

But we have chosen a different stock to focus on here - United Arab Emirates-focused private hospital provider NMC Health. It earns revenues in the UAE Dirham, which is pegged to the dollar, and hence reports in dollars: turnover broke the $1bn mark at the most recent full-year results as the company has continued to add beds. It is feeding a fast-growing market, with a wealthier society more likely to spend on private healthcare, and more likely to pick up the lifestyle illnesses we suffer in the western world (read our Sector Focus from May): preventative medicine is one area expected to grow strongly.

Regulatory intervention remains a risk, such as Abu Dhabi's attempts last year to encourage people towards the state-run sector. But NMC grew regardless.

Last IC View: Buy, 2,280p, 22 June 2017

 

Standard Chartered (STAN)

Of the banks listed in London, Standard Chartered is arguably the most insulated from any Brexit ill effects - although buy tip HSBC (HSBA) isn't far behind, partly because of its scale and reach.

For StanChart, the smallest contribution of its four regions comes from Europe & Americas, generating $34m of underlying operating income last year out of a $4.7bn total, with the lion's share coming from Greater China & North Asia for this emerging markets-focused lender.

If you can buy into its recovery story, that is. Its first-quarter results supported this in terms of lower loan losses, but growing income in its major markets is proving more of a challenge. Group chief executive officer Bill Winters has done a good job of reducing the company's risk-weighted assets, and despite rising by a quarter over the past year, the shares trade at just 0.8 times expected book value. There's no dividend yet, but there's a value argument and the long-term growth potential of the Asian market.

Last IC View: Hold 726p,  27 Febraury 2017

 

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Bango (AIM:BGO)

This one comes from our columnist Simon Thompson. Mobile payments company Bango has seen its share price triple over the past year, helped along by a deal sealed with Amazon (US:AMZN) in Japan that allows consumers to purchase goods on Amazon's Japan site and have them charged to their mobile phone account.

Carrier billing is popular in Japan, and the two phone operators account for three-quarters of the subscriber market, so this should provide a big boost for Bango. It has also extended its partnership with another tech giant, Microsoft, last year, and launched Google Play carrier billing activation in India with telecoms company Idea Cellular. The EU including the UK generated just 2 per cent of Bango's revenue in 2016, although this is a business that has yet to hit break-even.

It should start to generate a run-rate cash profit by the fourth quarter, thanks to end-user spend that is growing incredibly quickly. Simon has set a 200p target price based on a valuation of 13 times 2020 net profits, and says the Amazon deal is "transformational".

 

UBM (UBM)

As discussed in our recent Boardroom Talk podcast, UBM's (UBM) 'Events First' strategy has thus far delivered for shareholders, focusing it on the business-to-business events sector and providing cash from non-core disposals.

The company expects further progress in margins and continued good cash generation - in 2016 cash conversion sat at 96 per cent. The global and sectoral spread of its events provides some protection in diversification. Arguably, this isn't reflected in the rating. UBM's shares trade at 14 times next 12 months' earnings, according to Capital IQ data, compared with a five-year average of 21 times.

In 2016, the company generated £712m from events, of which the UK accounted for £36m and continental Europe £59m. The acquisition of Allworld for $485m, an events business focused on Asia and the Middle East, and other bolt-on acquisitions are bolstering the company's pitch: a globally focused events provider, which has severed ties with less lucrative domestic markets.

Last IC View: Buy, 760p, 23 February 2017

 

Wolseley (WOS)

The business soon to be known as Ferguson, after its major US business that makes the vast majority of its profits, has a lot more than one foot on the other side of the pond. It will report in dollars from August.

Indeed, there is a chance that the plumbing and heating specialist ends up selling its European operations entirely. Trading across the pond has been strong, led by a recovering US economy, so there is good grounds to expect further progress on earnings. Liberum analysts also expect the company to restart capital returns after the completion of the disposal of its Nordic businesses, to the tune of £2.9bn over the next four years.

The streamlined Ferguson business will be generating 90 per cent of its profits in its best market. The shares trade at 16 times this year's earnings, falling to 15 times next year. The group does not see any material impact from Brexit on its trading. We agree, and upgrade to buy.

Last IC View: Hold 5,265p, 28 March 2017