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Three stocks to watch for in the event of a Brexit

19 March 2016

Alan Custis, head of UK equities at Lazard, tells FE Trustnet which companies could be set to either benefit from a Brexit or will defend against volatility caused by a ‘leave’ majority decision.

By Lauren Mason,

Reporter, FE Trustnet

The prospect of a Brexit has dominated headlines recently, with almost a month still to go before the official campaign period begins on 15 June.

Understandably, this has left UK investors feeling confused as to where to put their money, given that nobody is able to predict how markets will behave whether we leave or stay in the EU.

Alan Custis, head of UK equities at Lazard (pictured), believes that a ‘leave’ vote could severely bruise the home market as we are more dependent on the EU as a trading partner than they are on us.

“Do we think that with a Brexit vote, Germany and France are going to welcome us with open arms? No. When global companies are thinking, ‘should we have the UK as a location or should we think about somewhere else?’ I think there will be huge inertia in terms of investor decision and therefore I don’t think, despite what people are saying, a Brexit would be a momentary blip,” he told FE Trustnet recently.

However, he says there are still plenty of individual stocks from a bottom-up perspective that could offer attractive opportunities despite Brexit concerns.

As such, Custis offers the below list of stocks that could be set to protect against or even benefit from a potential ‘out’ vote.

 

Merlin Entertainments

This FTSE 100 stock hit the headlines last year following the tragic incident in which four Alton Towers visitors suffered life-changing injuries in a rollercoaster crash.

Unsurprisingly, this caused the stock’s price to plummet and between June and the end of September it had fallen by 20 per cent.

Custis and his team bought into the stock when valuations were particularly low as he has always liked the company notwithstanding the accident, which was later found to be the result of human error as opposed to a mechanical fault.

In the event that sterling weakens in both the run-up to the referendum or as a result of a pro-Brexit vote, the manager believes the stock would be set to reap the benefits on a transactional basis.

“Sterling weakness could make it more attractive for tourists to come into the country, and which company has the number one amount of tourist attractions? It’s Merlin obviously and with London being a disproportionately big part of their portfolio, they would be a clear beneficiary,” he explained.

“The stock has recovered all of what it lost around the Alton Towers tragedy and more, because in that particular incident the ride didn’t mechanically fail. That’s not condoning it of course and the HSE [the Health and Safety Executive] are going to be throwing their book at them but that’s all priced into the market now.”

Since the stock floated on the London Stock Exchange in 2013, it has provided a total return of 33.84 per cent, outperforming the FTSE 100 index by 34.18 percentage points.

Performance of stock vs index since IPO

 

Source: FE Analytics

Merlin Entertainments has a price-earnings ratio (P/E) of 27.08 and a price-to-book value (P/B) of 4.01. It has an earnings-per-share (EPS) growth of 5 per cent.

 


 

British American Tobacco

In an article on Tuesday, Custis emphasised the importance of buying into defensive, global-facing stocks despite historically high valuations.

“It’s arguably different at the moment and therefore if a stock is giving you 3 to 4 per cent organic top line growth, is managing its costs and growing its earnings at 6 to 7 per cent as well as growing its dividends at 5 per cent, it’s almost like a bond with a growing coupon. Why wouldn’t I pay 20x or 30x for that at the moment with no clear-cut economic growth on the whole?” he said.

One such stock that he currently holds in his Lazard UK Omega fund is British American Tobacco, which is the second-largest individual weighting at 7 per cent.

The £76bn tobacco giant is renowned for being a ‘stalwart’ stock with a reliable income but many investors could be deterred by its seemingly hefty price tag.

“We still think this looks very cheap. Optically it looks expensive but the reason for this is because it has a big associate which is Reynolds in America, which it is 42 per cent of,” he said.

“When you have an associate that accounts for 30 per cent of your profits, you take into account the net debt but the associate’s income doesn’t come into EBITDA [earnings before interest, taxes, depreciation and amortisation] so it looks expensive but this isn’t an accurate reflection because of its structure.”

“We think it’s cheap. It’s a well-run tobacco business and they remain at the forefront of innovative product launches, whether it’s the low heat cigarette they have coming out or the range of major e-cigarette brands they have, so we think that they’re in good shape. Primarily though, we like them from a valuation standpoint.”

Year-to-date, BAT has comfortably outperformed the blue-chip index with a positive total return of 9.18 per cent compared to the FTSE 100’s loss of 0.14 per cent.

Performance of stock vs index in 2016

 

Source: FE Analytics

The stock has also done well over the longer term, having outperformed the index more than six times over the last decade with a total return of 316.25 per cent.

BAT has a P/E ratio of 17.88 and a P/B value of 15.29. It has an EPS growth of 38.18 per cent.

 

Centrica

While Custis doesn’t hold this stock currently, he says Centrica could be a good play for those worried about a Brexit but who still want to buy into the UK market.

“We import a lot of gas from Norway, which would become quite expensive; we import electricity from France which would be more expensive; but we’d probably get a compensating increase in the power price, so some of the utilities like Centrica could be a viable option,” he said.


 

“We don’t hold it, but maybe a way of playing a Brexit could be through these stocks, although from a transactional basis it’s quite difficult to see who the beneficiaries would be.”

“You can avoid the stocks that will suffer a particularly hard landing though. You can paint quite a negative picture around financial services in the short term. Economic growth in the UK is likely to struggle too and therefore you don’t want to hold any pure domestics.”

Utilities giant Centrica has been hit particularly hard by the plummet in commodity prices and the fall in household bills over the last 18 months, announcing last month that its energy profits were down to £255m during 2015. As such, it confirmed a dividend cut despite its major competitor British Gas announcing a significant increase in profits over the same time frame.

Performance of stock vs index in 2015

 

Source: FE Analytics

If Custis is correct though, this could mean that the stock is a good value play given its underperformance.

Centrica has a negative P/E ratio of 15.09 and a P/B value of 8.33 cent. It has an EPS growth of 26.24 per cent.

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