ISEQ Offers Promising Potential If a Messy Brexit Can Be Avoided
Darren McKinley, CFA
Darren McKinley, CFA

Irish PLC profits decline by 15% in FY 2018! This is a headline you might expect to read early this year as Irish companies report FY 2018 financial results post a 22% fall in the ISEQ over the last year.

The reality is that Irish listed shares have been caught up in the Brexit tsunami with investors pricing in a bad fallout for Ireland Inc, in the case of a “no-deal” scenario. Given the constant news feed of what can only be described as a political shambles in Westminster, investors should be nimble. We think the ISEQ is currently assigning a much higher probability (c. 50%) to a disorderly “no-deal” Brexit than we view the risk of such an event (c.25%).

Irish public companies are in fact on course to report c.4.9% earnings growth in FY 2018 led by Smurfit Kappa. Ryanair & Paddy Power Betfair are weighing negatively on the average Irish company profit growth. A review of mid-cap Irish PLC earnings growth would imply an even stronger c.9.7% earnings growth for FY 2018.

Consensus currently expects Irish public companies to deliver a stronger c.7.7% earnings growth in FY 2019. A lower €/$ rate, as seen in the second half of 2018, should help support the H1 2019 profit growth outlook for Irish public companies with significant overseas revenue. We expect modest revenue growth and stable profit margins in 2019.

Despite the sell-off in shares, we do not view the financial stability of Irish public companies as a concern for investors. The Irish banks are well capitalised and the average public company free cash flow yield is running at c.6% in 2019, the highest in five years.

While a “no-deal” Brexit is a real risk, we believe the probability of such is reflected in current share prices. Investors are reluctant to invest based on a successful outcome, in which case a UK recession would likely be avoided. A “managed no-deal”, the current draft agreement or “Bremain”, would support the growth outlook for the UK and reduce the risk of an Irish company earnings recession in 2019.

In the event of a “no-deal” Brexit and/or a general election were Labour to get into government, the ISEQ could fall a further 5-10%. Worst case could see earnings fall 10-15% in FY 2019 but in our view Irish shares are already discounting a 20% decline in earnings at current levels. There is no-doubt that a “no-deal” hard Brexit would be bad for the UK, Ireland & Europe and it is for that reason we are hopeful that measures would be taken to support economic growth and company earnings temporarily. In December, we have already seen the EU & UK adapt a framework to help protect against the worst case.

At a domestic political level, extension of the confidence and supply arrangement and securing EU backing for resistance to a hard border could both be considered as economic wins, as it reduces uncertainty for businesses. Economically, 4.9% GDP growth in 2019 remains plausible.

As we begin 2019, with global growth forecasts revised down and investors hugely de-risked we see potential for economic growth to surprise to the upside. With inflation contained, monetary policy could remain supportive. Fiscal policy could be ramped up to support growth after a long period of austerity.

The longer “Brexit” and the US/China trade war are unresolved, the greater the risk that uncertainty starts to weigh on business investment, that earnings are revised down and investor sentiment weighs.

The ISEQ now trades on 14.5x trailing earnings, the cheapest multiple in seven years. Shares have been sold off as American investors reduce European exposure, yet earnings continue to hold up relatively well.

We are tactically bullish on the Irish share price performance in 2019, with an expected return of 16% (-10% in worst case (“no-deal”), +30% in best case (“Bremain”)). We expect the ISEQ to base in Q1, as we get certainty on the terms of Brexit before rallying over the course of the year.

Our preferred stocks are CRH, AIB Group, Smurfit Kappa, Total Produce, Dalata Hotel Group, Cairn Homes and Applegreen. In sterling, we see most upside in Grafton Group.

In the event of a “no-deal”, and we get a further leg down in markets we would look to add to Ryanair, Kingspan & Bank of Ireland as these stocks are likely to be hit hardest in a messy Brexit but offer solid long-term returns.

The full analysis on Irish equities is available within this month’s Investment Journal.

To speak with a Portfolio Manager or Account Executive today, please phone the Cantor Fitzgerald dealing desk on 01 633 3633.

Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up.