Former Commission head, José Manuel Barroso, believes an 11th hour deal remains possible despite the impasse over the Irish border arrangements, which makes you wonder whether a grubby little settlement has already been cobbled together well away from the public gaze.
All of this has been doubly frustrating for investors, and not just those who would have been happier if the status quo had been maintained following the EU referendum. Business leaders crave clarity above all else, and given how the negotiations have lumbered on, many probably wouldn’t object to a blatant political compromise on the part of the government – but the risk to business wouldn’t end there. For if the eventual settlement does fall short of the commitments set out in the last Conservative party election manifesto, then the Tories (as was the case in 1997) could struggle to ‘get the vote out’ at the next general election, leaving the way open for a Corbyn government with all the attendant implications for the UK stock market.
This scenario came to mind when my colleague Megan Boxall said we should reexamine the investment case for ‘bond proxies’ in light of the Fed Funds rate rise and subsequent market sell-off. For the former state utilities within that category, the likes of SSE (SSE) and Severn Trent (SVT), the prospect of a Labour government now represents an existential threat. At the recent party conference in Liverpool, the shadow chancellor, John McDonnell, reaffirmed his intention to seize back control of Royal Mail (RMG), the railways and the water and energy industries.
Admittedly, we’re not looking at a wholesale realignment as per the Atlee government programme of 1945. John McDonnell has stressed that the nationalisation programme for energy would be a gradual process, while shareholders in water companies could be compelled to trade shares for bonds: the state would still need to pay bondholders interest, with any remaining profits returned to consumers via price cuts – sounds almost too good to be true.
The mere prospect of renationalisation acts as a disincentive to invest in former public utilities, which is probably welcomed by the Labour leadership as it will dampen valuations if they ever have to make good on their electoral pledges. However, I wonder if the shadow chancellor has looked at the debt profiles of some of the privatised utilities, particularly the water companies, as some of them might find it hard to match existing rates of profits and free cash flow (ergo consumer price cuts and bondholder repayments) if interest rates keep ratcheting up.
As for the bond proxies that Megan was referring to, the likes of Unilever (ULVR) and British American Tobacco (BATS), neither is trading at a prohibitive multiple, at least relative to their historic total returns. Both groups carry large amounts of debt, so if you look at what you’re paying for the underlying business via the enterprise/cash profits (EV/Ebitda) multiple, the respective forward ratings of 14.5 and 10.2 are hardly outlandish. Indeed, in the case of BATS, you’re looking at implied share price upside of 35 per cent based on its historic trading premium relative to peers such as Imperial Brands (IMB) and Philip Morris (US:PM). Of course, this says nothing of the underlying trading performance (let alone, BATS’ regulatory challenges in the US), but the numbers cited certainly don’t hurt the investment case.
