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Post “Brexit” what should work

“There are decades where nothing happens; and there are weeks when decades happen”; Lenin

Broadly the dust is now settling. What is the early impact of “Brexit”…so far?

  1. Weak sterling “low for longer” due to lower interest rate support, less confidence in the UK’s prospects outside of the EU. We expect the Bank of England will lower Base Rate to 0.25% on the 4th August 2016. Finally we see the Brexit “shock” as only slightly slowing UK GDP in 2016.

    STG has settled well below the long term trend support at US$1.50 (31 year lows). This helps FTSE100 earnings.
    STG has settled well below the long term trend support at US$1.50 (31 year lows). This helps FTSE100 earnings.

  2. A possible UK constitutional crisis as the government moves towards Article 50 but without a solution for Scotland and Northern Ireland.
  3. The drivers of the UK consumer, the property market and wage growth could be more sluggish as Brexit “shock” is absorbed.
  4. The UK government is looking at stimulus measures, more infrastructure spending & specific actions for weaker industrial areas.

In this currency sensitive environment, broad groupings have emerged:-

  1. “Winners” – “large cap” UK multi-national beneficiaries of the UK devaluation due to overseas revenue exposure. This list comprises a spectrum of oil & gas majors, pharmaceuticals, HSBC and Standard Chartered, a range of exporters such as BATS, Imperial, Diageo, Rolls Royce. The primary reason is USD or EUR dividends.
  2. “Losers” have been UK insurers (due to EU pass-porting risks), housebuilders (UK property concerns), the UK centric retail banks, publicans, airline and travel companies (weaker UK demand for short haul travel), large retailers (costs in Euros/ USD linked currencies).
  3. Gold and silver have seen more UK based interest as a sterling hedge

The risk of “overshooting” in fast moving environments is real. Some of the “Losers” have been oversold and we see opportunities in UK centric companies with track records of achieving growth.

GSK – FTSE 100 – BUY

GSK is a leading UK pharmaceutical/ consumer healthcare company formed via the 2000 merger of Glaxo with Smithkline Beecham. GSK’s initial success was attributable to its development of Zantac, a leading anti ulcer treatment one of the world’s first “blockbuster” drugs. The GSK business is split into three major divisions, i) Pharmaceuticals ii) Vaccines and iii) Consumer Healthcare. The board has promised to pay 80p per share in dividends in 2016 and 2017.

Company GSK

Key Catalysts

GSK reports results in sterling yet its revenues are mostly in USD and USD linked emerging markets currencies. The decline in sterling from its Q1 result ($1.44) to $1.32 should of itself boost GSK EPS by c. 10%.

The board has to date delivered £400m of cost savings of its total £3bn annual cost savings plan by end 2017.

We are positive ahead of interim results, due on the 27th July 2016.

Share Price 1646p
Target Price 1800p
52 Week Hi/Low 1662p/1237p
Shares O/S 4.872bn
Market Capitalisation £80.1bn
Avg. Daily Volume 7m
Dividend Yield 4.84%

Source: Fidessa plc

Key Risks to Price Target

  1. A new Clinton Administration could revisit the issue of pharmaceutical pricing. At present the USA is the only major pharmaceuticals market where pricing of drugs is unregulated.
  2. GSK profit growth is partly dependent on delivery of targeted £3bn in annual cost savings by end 2017.
  3. GSK drug development pipeline is mainly early stage, in Phase 1 (safety) and Phase 2 (efficacy) trials. Only 8 of its 40 drugs in development are in later stage Phase III (large scale clinical trials).

Topps Tiles – FTSE Small Cap – BUY

Topps Tiles is a UK supplier of tiles with an 18% market share of a £640m annual market) It has grown net profit consistently from £5.7m in 2011 to £12.85m in 2015 due to store additions/ capacity expansion / margin growth. The positive UK property backdrop (national average prices have jumped from £120k to £175k since 2011) and competitor closures post 2008/9 have helped Topps add market share. Topps Tiles is run by Matthew Williams, the son of founder Stuart Williams. The family’s combined shareholding is c. 11.37%.

Q3 trading update (6th July) with like for like sales growth +6.2% demonstrated a good customer reception to recent product ranges changes. Topps is likely to meet EPS forecasts of 9.16p for 2016.

Company Topps Tiles

Key Catalysts

Topps recent working capital improvements, a decline in inventory days are positive backdrops. The board has also flagged margin gains from exiting wood products/ Topps Clearance.

Topps is well positioned for a likely softer 2016 post Brexit.

Topps has reversed c 27% since 22 June on concern over margins.

.

Share Price 107p
Target Price 150p
52 Week Hi/Low 165p/96p
Shares O/S 196.06m
Market Capitalisation £210.5m
Avg. Daily Volume 730k
Dividend Yield 3.05%

Source: Fidessa plc

Key Risks to Price Target

  1. UK store rollout target of 450 (from 342 now) could strain capital resources
  2. DIY/ refurb demand is sensitive to UK property trends, and sales turnover
  3. Topps Tiles product sourcing costs (it purchases tiles in Europe) and hence margins will be impacted by the lower value of sterling against the Euro

DFS Furniture – FTSE 250 – BUY

DFS Furniture is a leading UK/ Eire/ Netherlands/ Spain furniture supplier operating via its namesake stores, and other names, Sofa Workshop and Dwell. Former owner Advent International floated DFS on the LSE Official List in March 2015. DFS growth has come primarily from store expansion.

Company DFS Furniture

Key Catalysts

The directors were confident of DFS competitive position, its strategic initiatives and market share capture going into H2 2016. DFS is hedged against Far East product sourcing costs for FY16 but not FY17.

DFS is committed to 10.5p in annual dividend (40%-50% payout ratio) suggesting Fy16 EPS of 21p-26.25p) against a consensus forecast of 23.2p.

 

Share Price 211p
Target Price 300p
52 Week Hi/Low 349p/181p
Shares O/S 211.8m
Market Capitalisation £448m
Avg. Daily Volume 243k
Dividend Yield 4.48%

Source: Fidessa plc

Key Risks to Price Target

  1. DFS product sourcing will be impacted by weaker sterling increasing costs of goods sold
  2. Advent International, a 24% DFS shareholder have been selling down its DFS stake (most recent transaction 30m shares at 300p ps)
  3. Furniture demand is cyclical in nature and sensitive to UK property trends.

Conclusion

We are confident that the sterling devaluation and imminent Bank of England measures will stabilize the UK economy after the Brexit event. As such the sell-off in UK centric companies is possibly overdone.

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