Brexit Leaves Three Sectors in Disarray

June 30, 2016

Unless you’ve been living under a rock since Thursday, you’ll know that Britain has voted to leave the EU. Predictably, this decision has prompted chaos in the markets. In the two trading days following the vote, the FTSE 100 was down 5.6% and the more U.K.-focused FTSE 250 had slumped 13.7%. Three sectors in particular have been hit hard: banking, house-builders and airlines. Here, we will look through some of the key challenges the sectors face and what the prospects are.

House Builders

The house builders have been hit hard by Brexit. Berkeley Group, Barratt Developments, Taylor Wimpey and Persimmon have all fallen over 30% since the referendum result. Withdrawal from the European Union will allow greater control on immigration. Of course, immigration will not stop completely, but it will reduce — or so we are told! The fewer people entering the country, the fewer houses needed to house them.

house
(Getty)

Personally, I think this is a case of perception over reality. The impact of Brexit is not going take shape for at least another 12 months, probably longer, so the idea that things will change significantly in the short-term is simply not the case. However, more importantly, the U.K. has a significant housing shortage today. There is a shortfall of houses based on current numbers before we begin looking at what the future holds. Russell Quick of eMoov said: “The shortage is about 100,000 homes each year.”

The house-builders have profited, and will continue to, from failing housing policy that has created a mass shortage of houses for a growing population. The housing deficit has prompted the government to create more favourable conditions for house buying, which will strengthen house-builders. House-builders have a strong cash generation business model, which will bode well in times of uncertainty. Cash is king in uncertain economic times. Also, if the pound continues to weaken then this will encourage greater foreign investment from outside the U.K. into the property market, which will increase housing demand further. As a result,  there is plenty of profit and revenue generating opportunities for house-builders, and despite the potential slowdown in immigration there is still high demand for housing.

Airlines

Naturally, airlines have been hit by the vote to leave the EU, particularly easyJet and International Consolidated Airlines – both companies down over 40% and both have issued profit warnings in recent days. The withdrawal from the free movement of persons policy will complicated short-haul flights to popular tourist destinations on the continent. Budget airlines like easyJet may have to raise the cost of their flights to mitigate this problem.

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(Reuters/Paul Hackett)

Airlines will also lose access to the EU Open Skies Policy, which allows any airline of the European Union to fly between any point in the European Union and any point in the United States. This is less of a concern for short-haul providers, but could potentially be problematic for International Consolidated Airlines.

Again, it is important to stress these revocations will not be happening overnight. The bilateral agreements will take some time. The key bargaining chip for the airline industry is the British tourism market. Over 2 million Brits visited Greece last year. 12 million tourists visit Italy. 76% of British holidaymakers choose the EU as their holiday destination. British tourism means too much to too many EU member states. There are regulatory hurdles that need to be overcome, but it is in the interests of key EU member states to thrash a deal with similarly favourable terms. It benefits the member states as much as it benefits Britain.

With sterling weakening, this will put added pressure on companies in this sector as aviation fuel and aircraft are both priced in American dollar, but airlines have yet to see the record low oil prices from the end of the year come through on their bottom-line yet. There is uncertainty occupying the aviation sector, but, for me, these stocks are very undervalued.

Banking

In my view, the biggest concern is the banking sector.

As the EU has evolved over time, the collaboration of economic policy has evolved with it. There is a lot of intertwined fiscal policy that is favourable to EU member states, which will be difficult, if not impossible, to disentangle. The U.K. banks will no longer benefit from these policies.

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In addition to this, there is no quid pro quo. Unlike in the aviation example, EU member states will not be incentivized to smooth the transition for London-based banks. In fact, arguably the opposite is true. A number of EU capitals would like to lay claim to financial crown London currently wears. A key EU policy for the banking sector is the “Financial Passport,” which is an EU agreement that allows any firm in an EU member state can sell financial services to customers in other EU member states. This allows business to have a wide range of choice across the EU as to where they set up shop.

As a result, with less regulation than most of its European peers, London is the optimum city, for financial service firms in the EU. Companies could make deals EU-wide, while benefiting from the less stringent regulation. Obviously, when outside the EU, Britain may not have the benefits of the “Financial Passport” agreement. Of course, Britain will attempt to seek an agreement with similar advantages. However, with Paris and Frankfurt trying to forge financial hubs of their own, key EU member states such as France and Germany may look at this as one of the few benefits Brexit offers to them.

Three sectors in distress. Two to feel optimistic about, one to feel cautious about. Only time will tell what the fate is for these sectors, however, as the hyped-up Brexit rhetoric cools, share prices will probably begin to stabilise. Whether these companies return to the heights of their pre-Brexit highs, that remains to be seen.


guest

Tim Rooke is a writer for a number of financial publications including ADFVN, TradeSignaller and 7circles. As well as this, he writes for his own blog, Trader Tim’s Diary, which documents trading thoughts and ideas to help readers and other traders learn from both his trading successes and failures. Every trade recommended in Trader Tim’s Diary he makes himself and 10% of earnings will be donated to charity at the end of each month. In the first three months, he has made over £8,000 and rose over £1,000 for charitable causes. He can be reached via Twitter at @TraderTim5.

Cover image: Gregory Katz; Associated Press

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