The countdown is on: in less than one year, Britain will begin its transition period out of the European Union, and the March 29, 2019 departure still comes with a lot of uncertainty.
While the U.K. and EU have provisionally reached agreement on some Brexit issues and the terms for the 21-month transition, the future relations between the two sides are mostly unknown, and U.K. political groups are still campaigning against the move.
Britain’s Financial Conduct Authority (FCA) has called for the country to coordinate with the EU now to ensure Brexit is as smooth as possible, Reuters reported April 9. The FCA expects to spend “about 30 million pounds” to deal with the exit’s impact on the financial sector.
John Goetz of Pzena Investment Management in New York is watching the events closely. He predicts Brexit will likely result in volatility for the U.K. that might benefit fund managers.
One example is his firm’s investment in Travis Perkins, a Northampton-based builders’ merchant and home improvement retailer. “People’s negativity about the future for Britain has impacted [the company’s] valuation,” says Goetz, portfolio manager and co-chief investment officer at Pzena.
When geopolitical events weigh on holdings, he and his team “do the math” to better understand their positioning. In this case, they wanted to “better understand what the consequences of a very negative Brexit outcome would be—and that would be a very significant recession unique to the U.K. that no other part of the world is experiencing. [In that scenario], how would the company look?”
While Brexit will be a major event, he adds, “sometimes the market overreacts to these things, as they have in the case of Travis Perkins.” The company’s stock (LON: TPK) closed at 1,224 pounds on April 6, compared to 1,504 pounds a year earlier.
In a recession, Goetz’s calculations show the company would likely experience short-term market pain but have a solid long-term outlook. The main reason, he explains, is “it’s a business that requires a lot of inventory to serve customers.” In a recession, when sales volume goes down, such companies “can actually reduce inventory” and increase free cash flow.
“The fear about the business should be much lower but people don’t care because they’re selling things related to Brexit,” says Goetz.
Britain’s exit will impact the whole market, so he’ll also look for other opportunities. In particular, he may compare companies that are domiciled in the U.K. with similar businesses elsewhere to uncover hidden gems.
“If you find the same business that’s domiciled [in the U.K] versus somewhere else, you’ll have a bit of a cheaper opportunity in the form of a British firm,” from a valuation perspective, says Goetz.
For example, you could contrast WPP, a London-based advertising firm, with New York-based advertising giant Omnicom to see which is cheaper. Both companies’ stocks have dropped over the last year, but WPP dropped more than 500 pounds (or about US$750) to a close of 1,162.50 pounds on April 6, versus Omnicom’s approximate US$13 dip to a close of $US71.74 on the same day.
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