Postcard from London: 6 stocks that could rebound if/when Brexit happens

Financial journalist and commentator on 3AW and Sky Business
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Here we go again – another deadline for Brexit. New British Prime Minister Boris Johnson has vowed to take the United Kingdom out of the European Union (EU) by 31 October, without a “deal” if necessary.

This is after the last deadline, 30 March, was missed; which contributed to former Prime Minister Theresa May’s ditching. It is history that May’s negotiated “Withdrawal Agreement” will not be the deal that the UK eventually accepts.

In keeping with the incredibly fractious debate that has characterised Brexit since the initial vote in June 2016, the fear-and-loathing over the 31 October deadline is intensifying. The Johnson government may not get what it wants, but the markets now know that the British government is prepared for a complete break from the EU – the so-called “no deal” outcome, with the subsequent opportunity to negotiate a free-trade arrangement with it as a fully sovereign non-member.

The stock market will again fixate on the Brexit effect, especially if the UK leaves on 31 October without a deal – in particular, there are concerns for the UK’s world-leading financial services sector. Under the ‘passporting’ arrangement within the EU, UK-based financial businesses hold the reciprocal right to provide financial services in other member states under EU law.

It is uncertain what will happen with this arrangement – so the advent of Brexit could end the ability of London-headquartered financial services companies to operate across the EU, unless they set up subsidiary operations in the EU. Then again, the financial services heavyweights will still do a ton of work out of London for non-EU clients.

The financial services sector has been a prime candidate for concern from Australian investors about the potential impact of Brexit – stocks such as ASX-listed UK bank holding company CYBG (which owns Clydesdale Bank, Yorkshire Bank, Virgin Money UK and the app-based bank B in the United Kingdom, investment bank Macquarie Group, funds managers Pendal Group and Janus Henderson, property group Unibail-Rodamco-Westfield and financial markets and wealth management software and systems provider IRESS have all been marked down from time to time on Brexit fears.

So have companies with growing businesses in the UK, for example small-business accounting software provider Xero, buy-now-pay-later service provider Afterpay Touch, retail group Premier Investments (which is expanding its Smiggle stationery chain in the UK), private hospital operator Ramsay Health Care, travel group Webjet and wine company Treasury Wine Estates. In these cases, much of the worry surrounds the effect on the British economy and Britons’ spending habits.

In reality, many of these companies have plenty of other factors – both good and bad  – that are far more relevant to the stock price than Brexit.

Here are six stocks that have had a fair bit of Brexit uncertainty priced-in to the stock valuation – but which could rebound if and when Brexit happens, and fails to produce an economic cataclysm.

1. CYBG plc (CYB, $2.83)
Analysts’ consensus target price: FN Arena $3.63, Thomson Reuters $3.51
FY20 estimated yield: 5.6% (at current exchange rates)

As the only British retail banking group listed on the ASX, CYBG (Clydesdale and Yorkshire Bank Group) – which operates the Clydesdale Bank brand, which was established in Glasgow in 1838, and its sister brand Yorkshire Bank, which was founded in Halifax in 1859 – has been a lightning rod for Brexit concerns. In 2017, CYBG took over Virgin Money to create the UK’s sixth-largest bank, with 6 million personal and small business customers, and total lending of £70 billion ($116 billion). This year, CYBG has announced plans to re-brand to Virgin Money to take advantage of the wider recognition of the name, and also leverage the fact that the Virgin brand attracts a more affluent customer. The combined entity will have the scale to compete nationally, and attract the kind of market multiple that the larger UK banks command. Virgin Money will be looking to change its business mix, in particular by boosting business loans and unsecured personal lending: at present these represent just 10% and 6% of the loan portfolio respectively, dwarfed by the mortgage book, at 84%.

CYBG is mainly affected by the outlook for its key lending markets, UK homeowners and SMEs, is more subdued than in recent years. UK economic conditions are challenging. It operates in a heavily competitive mortgage market, and is affected by negative sentiment on house prices and higher costs from a changing regulatory landscape. Like all British businesses, it would like to know for certain what is going on with Brexit – and it has not boosted business lending growth by as much as it had hoped – but analysts view the stock as over-discounted for Brexit risk.

2. IRESS (IRE, $12.69)
Analysts’ consensus target price: FN Arena $13.80, Thomson Reuters $13.60
FY20 estimated yield: 4.1%, 60% franked

The financial markets and wealth management software and systems provider is a big player in the London market – it counts many of the biggest asset managers in the world as its clients. If there were to be a downturn in the activity of the London financial market post-Brexit, IRESS could suffer. IRESS generates about one-quarter of its revenue in sterling, so the value of the British currency also affects its profitability – a no-deal Brexit would be likely to send sterling lower, and cut into IRESS’s profit. This month, a survey of analysts conducted by Bloomberg arrived at a consensus that no-deal would see the pound tumble to its lowest level since 1985.

However, IRESS has major businesses in Australia, Asia-Pacific, South Africa and Canada that would not be greatly affected by Brexit. The company’s UK operation is also exposed to the advice/wealth software market, for which analysts feel the outlook is broadly positive. On consensus price target grounds, IRE looks under-valued.

3. Webjet (WEB, $13.28)
Analysts’ consensus target price: FN Arena $17.07, Thomson Reuters $16.50
FY20 estimated yield: 2.7%, fully franked

Online travel agency Webjet has encountered Brexit jitters because of its 2016 deal with British travel group Thomas Cook under which WEB manages the bookings for Thomas Cook’s hotel rooms, through its business Sunhotels. Thomas Cook blamed Brexit (and hot weather) in the UK last summer for recent weak performance, and that flowed through to WEB: after a strong start to the year, the Webjet share price has recently been at the mercy of Brexit uncertainty – as well as the “wealth effect” of weaker house prices on consumer confidence and spending at home. But the company’s hotel comparison service, WebBeds, is now the market leader in the Middle East and Africa, and Webjet says there is room for the service to grow in the Asia-Pacific market. Ultimately, that will be a bigger impact on WEB than Brexit. This is another under-valued Brexit victim.

4. & 5. Janus Henderson (JHG, $28.50)
Analysts’ consensus target price: FN Arena $31.16, Thomson Reuters $31.70
FY20 estimated yield: 7.7% (at current exchange rates), unfranked
Pendal (PDL, $7.14)
Analysts’ consensus target price: FN Arena $8.44, Thomson Reuters $7.99
FY20 estimated yield: 6.8% fully franked

Virtually every piece of commentary about this pair of fund managers talks about Brexit uncertainty – but the metrics that really drive these businesses is funds under management (FUM) growth, and that’s what is really behind recent share price difficulties; particularly in the case of JHG.

Earlier this month, JHG was pummelled, after it revealed a record level of outflows in the second quarter – a much worse-than-expected $US9.8 billion ($14.3 billion) of outflows for the global fund manager. In particular, the manager’s Intech product line and its emerging markets equities funds products performed poorly. Also, the market was arguably not impressed by the decision to let co-CEO Andrew Formica – who came to the merged group from Henderson – go, leaving former Janus head Dick Weil as the sole CEO. JHG shares slumped 16% on the news. All of these were business decisions, not Brexit effects – but JHG is spoken of as Brexit-discounted, because about 60% of its earnings come from the UK and Europe. Analysts think the sell-off in JHG has gone too far – while Pendal, which has not suffered anywhere near the FUM losses that Janus Henderson has, is in the same boat.

 6. Bravura Solutions (BVS, $4.49)
Analysts’ consensus target price: FN Arena $5.50, Thomson Reuters $5.50
FY20 estimated yield: 2.4%, unfranked

Financial services software provider Bravura has more than half its business in the UK, mainly in its flagship Sonata wealth management administration software, so it has been one of the perceived Brexit-exposed stocks dragged lower in recent months – but the stalled takeover of rival GBST would also have played a part in that. There is some risk of Brexit-related slowdown in financial services, but it pales in comparison to Bravura’s strengths in the digital administration of investments and wraps, superannuation, life insurance and private wealth – in fact, in the UK, life insurance and pensions regulatory changes are driving the market toward upgrading to digital solutions, and the company will ultimately benefit from a more sophisticated financial services economy – in all of its markets, not just the UK. It’s Brexit, Schmexit, for Bravura.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

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