Brexit: This Could Be a Very Big Economic Shock – Levered, Europe-Exposed Companies Most at Risk

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Graham Copley / Nick Lipinski



June 27th, 2016

Brexit – This Could Be a Very Big Economic Shock – Levered, Europe-Exposed Companies Most at Risk

  • In our view, the UK leaving the EU is important, but on its own and handled smoothly would be of limited impact to the global economy.
    • But it is not likely to be a contained event and this is the fear that has gripped the market and is what constitutes the bigger risk.
    • The UK is one of the stronger economies in Europe and its loss will likely place a greater funding burden on Germany and the other strong economies as well as increase pressure on the weaker countries to improve economic growth in line with EU goals – increasing pressure on these countries to think about exit as a better option than staying.
    • If we saw political order in the UK or a consistent view of what to do next in Europe we might feel less negative, but we have neither.
  • In short, Brexit could precipitate a broader restructuring of the economic union.
    • This greatly increases uncertainty – driving lower consumer and business confidence – lower investment, and the inevitable consequence, lower economic growth.
  • Add to this volatile currencies and the risk of a meaningful loss of confidence in the Euro as well as the Pound, and you can quickly paint a very bleak picture.
  • Instinct leads one away from companies with significant European revenue and income exposure and towards those that are more US centric.
    • But not those exposed to what could be much cheaper imports from Europe – Autos for example, some capital goods but possibly also commercial aircraft.
  • The other major negative could be a weaker oil market – more based on sentiment (against the backdrop of high global inventories) – while US natural gas (un-impacted by Europe) remains stronger. This undermines the energy based competitive advantage in the US for any high energy user but particularly the chemical industry.
    • Commodities in general should weaken (except gold) – which is another major headwind for steel and aluminum.
  • No one wins in an economic shock as we all saw in 2008/9 and this could be a trigger of similar proportions – Industrials and Materials WILL underperform the broader market and more levered companies could face bigger problems than just a lower share price.

We include some charts and tables below which show exposure to Europe and debt burdens – the more obvious pair trades are: LYB/WLK, FDX and UPS/Rail and Truck, AGCO/OSK.

The more obvious names to avoid completely (or short) because of their balance sheet and how much of their EV is debt are: DE, CNHI, CC, TROX, HUN and X.

We identified an economic shock as one of the more significant risks to our preferred names, DOW and DD in research on June 24th. We also believe that a weaker Euro puts a MON purchase by Bayer at risk unless MON takes a lower price.

Exhibit 1 – Most Europe-Exposed Sales in Industrials & Materials

Source: Capital IQ and SSR Analysis

Exhibit 2

Source: Capital IQ and SSR Analysis

(NOTE: DE includes debt attributable to John Deere Capital Corp)

Exhibit 3 – Most Europe-Exposed Sales by Sector

Source: Capital IQ and SSR Analysis

Exhibit 4 – Least Europe-Exposed Sales in Industrials & Materials

Source: Capital IQ and SSR Analysis

Exhibit 5 – Companies with Debt Maturing, 2016

Source: Bloomberg and SSR Analysis

Exhibit 6 – Companies with Debt Maturing, 2017

Source: Bloomberg and SSR Analysis

©2016, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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