Although polls now point towards an increasing likelihood of Britain remaining in the European Union, it’s far from being a certainty. There are another four weeks before the EU referendum, and a lot can change in that time.
It may therefore be wise for investors to protect their portfolios against the shock of leaving the EU by buying stocks that could benefit from a “leave” vote. With this in mind, I’ve selected these three stocks: Royal Dutch Shell (LSE: RDSB), BHP Billiton (LSE: BLT) and Standard Chartered (LSE: STAN).
Foreign income
You may be surprised that I have chosen three rather cyclical stocks, but because these companies earn an overwhelming majority of their income outside of the UK, they are somewhat shielded from the potential effects of Brexit on domestic economic growth. Moreover, they will benefit from the likely slide in the value of sterling.
Leaving the EU would almost certainly bring about an immediate slide in the value of the pound – it’s such a serious risk that the Bank of England has already drawn up contingency plans to deal with the anticipated sudden outflow of sterling assets. Analysts from investment bank UBS even think Brexit could cause the pound to fall to parity against the Euro in a matter of months – that’s potentially a near 25% fall in the value of sterling.
But a weaker pound would mean income earned in foreign currencies would translate into a higher sterling value – thereby boosting earnings and dividends.
Political uncertainty
Although a potential fall in the value of the pound is positive for companies with large foreign currency incomes, investors also need to consider the risk of political uncertainty from leaving the EU. A vote to leave the EU would likely lead a two-year period of negotiations. And during this period, businesses would face considerable uncertainty about the future ease of doing business across borders.
Even though these companies conduct most of their business outside of the UK, as UK-domiciled companies they would still be confronted with increased regulatory and legal uncertainty. Faced with such risks, investors could consider UK equities as more risky investments – possibly offsetting much of the benefit of a weaker pound.
Other considerations
These stocks may be good bets on Brexit, but investors should always take into account other considerations, particularly longer term fundamentals and valuations.
Shell has a tempting 7.5% dividend yield, but its earnings are heavily exposed to commodity price risks. Oil prices recently breached $50 a barrel, but the recovery does not seem sustainable with the continued supply glut in global markets. Furthermore, Shell faces headwinds in downstream profitability, which could undermine free cash flow generation and raise questions over its dividend sustainability.
Like Shell, BHP Billiton relies on a sustained recovery in commodity prices, which does not seem all that likely. The price of iron ore, which soared more than 60% between the start of the year and late April, is on the decline again. Prices have already fallen by more than a third from its peak, and further losses are possible.
Standard Chartered, the emerging markets-focussed lender, has to contend with the economic slowdown in Asia, which is resulting in lower profitability. On a P/B valuation, the stock is tempting, with the bank trading at 0.5 times book value. Unfortunately, it will take many years for earnings to recover, and its current forward P/E of 26.9 does not appeal to me.
