Analysis: Sharply reduced UK Plc could fall further

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  • UK shares are trading at a record price against their global peers
  • Valuations have plunged in several sectors
  • Economic outlook, credit costs and weak pound mean risks abound

LONDON, Nov 8 (Reuters) – British companies are trading at steep discounts of around 40% to global peers but are set to fall further, investors say as they weigh the risks posed by a gloomy economic outlook, lower costs rising borrowing and a volatile pound.

Although the rising costs of everything from labor to raw materials and energy following the post-pandemic supply disruption and Russia’s invasion of Ukraine will not is by no means limited to the UK, UK businesses had already been hit by post-Brexit investor pessimism.

Valuations have plunged across several sectors in tough times for many companies, including pubs group JD Wetherspoon (JDW.L)fashion retailer Joules Group (JOUL.L) and Khaki home builders (PSN.L)Taylor Wimpey (TW.L) and Barratt developments (BDEV.L).

Hani Redha, global multi-asset portfolio manager at US investment firm PineBridge, said UK valuations did not look cheap over a multi-year period and the “structural issues facing the UK economy”.

UK stocks (.FTAS) are already trading at a record discount to their global peers (.MIWD00000PUS)Refinitiv data shows, but investors expect new lows next year.

“Austerity is going to be a problem, the effects of Brexit on capital flows are going to be a problem, the pound is going to be a problem… On top of that we are going to go into recession,” Redha said. .

Discount in UK

The domestically focused FTSE 250 mid-cap index (.FTMC) snapped three straight quarterly declines after new Prime Minister Rishi Sunak scrapped most of his predecessor’s market-crushing budget plan.

But investors do not expect the recovery to last.

“The FTSE 250 is currently full of companies in precarious sectors,” said Vuk Magdelinic, CEO of financial market analysis provider Overbond, citing consumer discretionary stocks and the real estate sector among others.

“These sectors face a double whammy of rising capital costs and very low market liquidity,” Magdelinic said.

CORPORATE DEBT

Borrowing costs for businesses have soared due to the unfunded £45bn ($52bn) tax cut package announced by former prime minister Liz Truss’ government in September.

Although Sunak’s new budget plan is due on November 17, borrowing costs for sterling-denominated companies remain near multi-year highs, with the Bank of England raising interest rates to 3% in a bid to contain inflation while warning of the risk of a two-year recession.

The ICE BofA sterling non-gilt index (.MERUR00)which measures the prices of investment-grade debt, hit its lowest level since 2009 last month and has fallen about 20% this year.

The pound’s fall to historic lows against the dollar has only compounded the problem for UK businesses.

Half of all borrowing by UK non-financial corporations is in dollars, totaling around 350 billion pounds ($399.5 billion), according to S&P Global.

There is a silver lining, however. The refinancing needs of non-financial companies are modest until 2023, the rating agency added.

POUND AND FTSE 250 IN TANDEM

This year the FTSE 250 index, which is important in sectors that import goods and sell products domestically, has shown the most consistent positive correlation with the pound in nearly a decade, meaning that the two are more likely to evolve together.

Simon Keane, an equity specialist at investment bank Schroders, compared the performance of UK small-cap companies to that of their blue-chip counterparts on the FTSE 100, which tend to record much of their income in dollars and found that the gap between them was the largest for 30 years.

But it’s not all gloomy, Keane said.

“For UK small caps, an underperformance of almost 30% is statistically rare,” he said.

“Such dramatic underperformance was also, on average, the precursor to a period of strong outperformance versus the FTSE 100.”

PineBridge’s Redha said he would reassess UK stocks next year as he expects European and US stocks to bottom in the first half of 2023.

Stéphane Ekolo, equity strategist at the brokerage firm Tradition, is equally cautious.

“Bearing in mind the current state of the UK economy, I would stay away from UK small caps,” he said.

($1 = 0.8760 pounds)

Reporting by Joice Alves Editing by David Goodman

Our standards: The Thomson Reuters Trust Principles.

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