One year on from the UK referendum, we take a look at Brexit’s impact on the economy. What does it mean for company valuations?
Just over a year ago, on 23 June 2016, the UK decided 51.9% to 48.1% to leave the EU. After a closely fought campaign, this was a surprise outcome, especially so for many in the business community who have long benefitted from unencumbered trade within the EU in the largest single market in the world. In the run up to the vote, there were many theories proposed from Leave campaigners about what exiting the EU would actually look like, but nothing concrete. Since that historic date, the UK Government has tried to allay the fears and uncertainty surrounding an exit from the EU, but, as part of their negotiating strategy, have deliberately not given much detail. Following the first formal meeting between David Davis for the UK and Michel Barnier for the EU at the end of June, we look back at what impact Brexit has had on the UK economy and what it means for company valuations going forward.
One thing is for sure: the Brexit process will have a substantial impact on all sectors of the economy in both the UK and the EU, with both winners and losers. As a valuer, it will be critically important to understand both the risks and opportunities so we can see where value may be created or lost.
Volatility and devaluation of the Pound set to continue
The immediate impact was a devaluation of the Pound, which fell some 6% against the Euro and 8% against the Dollar the following day. Both exchange rates have continued to fall since then and are currently 13-15% below where they were on 23 June 2016. Share price volatility also shot up following the vote but eventually came down again. It is highly likely we will experience further volatility as negotiations progress, but for now there is little prospect of a return to pre-Brexit Euro and US exchange rates (bar a sudden and significant increase in UK interest rates).
So what does this mean?
The exchange rate movement has been a double edged sword – a blessing for those companies that primarily sell outside the UK (for example, one high-end UK fashion retailer only generates about 11% of sales from the UK), but a curse for those companies that import raw materials, goods and services from abroad. Some airlines have been particularly affected because of worries that British holiday makers would be put off due to the weaker pound, whilst making fuel (which it pays for in dollars) more expensive.
The knock-on effect of lower exchange rates was two-fold – at the listed company level, we have seen the overall FTSE 100 index move up significantly. There has also been an increase in inflation as imported goods and services have become more expensive.
The FTSE 100 index went from 6,338 on 23 June 2016 to 7,143 at the end of 2016, and is (at time of writing) around 7,400 mark. Commentators have linked this increase to the fall in the pound, as overseas earnings for the international businesses listed on the FTSE translate into higher earnings for UK reporting purposes. One might have suspected listed company multiples to have risen since Brexit, on the basis that there is a lag between companies announcing results and the movement in the equity markets. However, the average price earnings ratio for the FTSE 100 actually fell from 56.4x in June 2016 to 32.7x in May 2017. Over the same period the average EV/EBITDA multiple fell from 14.3x to 11x.
FTSE 100 P/E Multiples versus EV/EBITDA Multiples: