Iseq would surge 30% if Brexit ended
Irish Plc profits decline by 15% in 2018. Profit margins squeezed, as higher input costs bite. Investors grow concerned about the financial stability of Irish companies.
These are some of the headlines you might expect to read in the first months of 2019 as Irish companies gear up to report full-year financial results, if they were to reflect the drop of almost 21% in the Iseq Overall index in the past year.
The reality is that Irish listed shares have been caught up in the Brexit tsunami, with investors pricing in a bad fall out for Ireland Inc if there is no deal.
Given the news flow of the political shambles in Westminster, investors should be both alert and active.
But we think the Iseq is currently assigning a much higher probability, of about 50%, for a disorderly no-deal outcome, which we view as a 25% probability.
Irish companies are on course to report earnings growth of 4.9% for 2018, led by Smurfit Kappa. Ryanair and Paddy Power Betfair are weighing negatively on the average Irish company profit growth.
And a review of mid-cap Irish earnings growth would imply an even stronger — at 9.7% — in earnings growth for 2018.
We do acknowledge that profit margins are generally trading above the trend because the economic backdrop has been positive.
CRH acquired Ashgrove and Fels; Kerry Group acquired Fleischmann’s and AATCO Foods, and Glanbia acquired Slimfast.
These were just a few examples of Irish companies acquiring abroad.
We do not view financial stability of Irish companies as a concern for investors.
The Irish banks are well capitalised and the average company free cash flow yield will run around 6% in 2019, the highest in five years.
While a no-deal Brexit is a real risk, we believe the probability of such is reflected in current share prices.
Investors are reluctant to invest based on a successful outcome, which would likely avoid a UK recession, despite a greater likelihood of such an outcome.
A managed no-deal agreement; the current draft agreement; or a so-called Bremain outcome would support the growth outlook for the UK in 2019 and reduce the risk of an Irish company earnings recession in 2019.
In the event of a no-deal Brexit and/or a UK general election with UK Labour taking power, the Iseq could fall a further 5% to 10%.
In the worst case, we could see earnings fall 10% or more in 2019 but in our view, Irish shares are already discounting a 20% decline in earnings at current levels.
There is no doubt that a no deal, hard Brexit would be bad for the UK, Ireland, and the rest of Europe and it is for that reason we are hopeful that measures would be taken to support economic growth and company earnings temporarily.
At a domestic political level, the extension of the confidence and supply arrangement and securing EU backing for resistance to a hard border can be considered as economic wins, as it reduces uncertainty for businesses.
Irish GDP growth of 4.9% this year remains plausible.
Although consumer confidence has recently dipped, retail sales and property prices continue to grow robustly.
The 5.3% unemployment rate and trade balance continue to contribute toward growth.
The Iseq now trades on the cheapest multiple in seven years.
Shares have been sold off as US investors reduce European exposure, yet earnings continue to hold up relatively well.
We are tactically bullish on the Irish share price performance.
We predict a fall of 10% in a no-deal outcome and a surge of 30% under the best case, Bremain outcome.
Our preferred euro picks are CRH, AIB, Smurfit Kappa, Total Produce, Dalata Hotel Group, Cairn Homes and Applegreen. In sterling, we see most upside in Grafton Group.
In the event of a no deal and we get a further leg down in markets we would look to add to Ryanair, Kingspan and Bank of Ireland as these stocks are likely to be hit hardest in a messy Brexit but offer solid long-term returns.
