Artisan Canvas

The Disparate Impact of Brexit on UK-Domiciled Companies

The Brexit deadline is looming. Again. While it doesn’t seem inconceivable the can could be kicked yet again, as things currently stand, the UK will leave the EU with or without a deal on October 31. For investors, a clear concern is just how a post-Brexit world will impact companies domiciled in the UK. While it’s nearly impossible to predict with any measure of certainty, the thought experiment is worthwhile.

Let’s start with a few basic assumptions: First, Brexit leads to a UK recession which doesn’t spread much beyond the UK’s shores—in other words, it’s truly a UK- and Brexit-centered recession, as opposed to part of a broader, global recession that impacts a swath of countries, probably including the EU. Second, it has a major impact on the pound. We’ll also assume Brexit will have a disparate impact on UK-centric companies (i.e., those which generate all or the vast majority of their revenues in the UK) and UK multinationals (i.e., those which generate at least a plurality—if not a majority—of revenues overseas).

In general, it’s fair to say multinational companies would be more stable in a UK-centric recession. Further, if the pound is weaker, all else equal, non-UK consumers will have an incentive to buy cheaper (or, relatively cheaper) goods from a UK multinational. However, UK multinationals’ costs may go up if intermediate costs sourced from overseas go up due to weaker pound. The net effect is impossible to determine in aggregate—rather, it would all depend on a case-by-case assessment of multinationals’ cost structures.

Even beyond that broad statement, it’s a bit hard to pull apart. Are companies we’re considering UK domestics truly domestic? The pound is only weak relative to another currency. If a UK company is operating within the UK, sourcing UK goods and selling to UK customers, everyone is transacting in the same currency—so weak or strong, there’s no net currency effect on those transactions. Now, a UK-centric recession would probably still weigh on demand for that company’s good—how much would depend on relative stickiness—but the currency wouldn’t be an issue. Most domestic UK companies are probably still sourcing intermediate goods from elsewhere, however, and a weaker pound would increase input costs (all else equal). That “all else equal” is always tricky, though—maybe the UK domestics switch suppliers, given rising costs. Etc. The web becomes complex very quickly.

Then there are broader, economic questions to consider—for example, how long is the UK likely in a severe recession if the rest of the world isn’t in one, too? Probably not that long, given how integrated with the rest of the world the UK is (even after Brexit). If the UK is truly headed for a deep recession, that probably means the rest of the world has a cold, too.

All of this highlights the benefits of deep, fundamentally oriented, bottom-up analysis. If, for example, one can find a quality UK multinational that is well insulated from the weight of a contracting UK economy and/or is less impacted by a weak pound, that might be an interesting investment at a time when investors generally expect all UK companies to suffer. Same token, if fundamental analysis can uncover a UK domestic firm with sticky or even counter-cyclical demand, or one that is early in a phase of expanding its offering overseas.

Then, too, consider that most well-run British firms—multinational or no—have had over two years to digest expectations of Brexit and take precautionary measures so that either an orderly or disorderly Brexit isn’t operationally disastrous.

Which means, there isn’t a short answer to, “How will Brexit impact UK firms?” or, “How should investors respond to Brexit?” The longer answer is to consider the range of possible scenarios, actions already taken by management, a company’s demand profile, its cost structure and how much your analysis may differ from consensus expectations.