Buchler Phillips Quarterly Bulletin No.8

The pride of Lions

British and Irish rugby fans may be forgiven for celebrating as though the Lions had won the June-July series against New Zealand. A win apiece, with a thrilling 15-15 draw in the final match, will have exceeded most expectations of the Lions, however impressive their form nowadays under coach Warren Gatland.  The All Blacks will undoubtedly continue to dominate world rugby for the foreseeable future. The trend is their friend, the Kiwis having won 77% of their last 556 international matches. But Gatland’s northern hemisphere  collective has much to teach businesses large and small about making consistent progress against all odds. 

An inconclusive General Election, Brexit uncertainty, currency woes, UK inflation and weak productivity all call for tough management prepared to make decisions for the long term future of their companies: putting team before star players, focusing on those ready to commit to a common goal; short-term pain and even surgery to ensure survival before growth; restructuring, reorganisation and making the very best of resources available. Perhaps hardest of all, taking calculated risks - doing things differently to achieve a different, better outcome.

Economic Outlook

Breathe in and wait for further belt-tightening all round, starting with UK banks. They have already cut back on unsecured lending, fearing a further economic downturn after Q1 2017 growth fell sharply from 0.7% to 0.2%. Relatively strong consumer spending in the aftermath of the Brexit vote has not been sustained. In the three months to May, higher inflation from lower sterling, coupled with average real pay falling by 0.7%, has squeezed UK consumers. At the same time, demand for credit has boomed, with the savings ratio at its lowest since 1963. Defaults on credit card lending are rising, although they are yet to hit bank profits. At this stage, the Prudential Regulatory Authority is urging supplier caution over risk, rather than knee-jerking with more expensive loans. The lessons of 2008 are front of mind with all banks and watchdogs at the moment.

On the Government side of the growth equation, the Office for Budget Responsibility says Britain will need to curb public spending further or raise taxes if leaving the EU does long-term damage to economic growth. Striking new trade deals is more important in the long term than the size of any divorce bill to settle one-off liabilities. The outlook for exporters needs to improve very significantly if it is to offset the effect of inflation on consumers at home. The Bank of England is sceptical and already flagging the prospect of a modest rate increase later this year, the first time in a decade, to help sterling and price rises.

The cost of divorce

While we at Buchler Phillips love nothing more than poring over figures and planning for different scenarios, assessing the nation’s bill for Brexit is not necessarily top of our to-do list. Thank goodness for one of our professional bodies: the Institute of Chartered Accountants in England & Wales has crunched the numbers and found a range of outcomes – low (£5bn), central (£15bn) and high (£30bn). Interestingly, even the worst case is far lower than other observers’ average projections, which the ICAEW sees as “extreme”.

In the central scenario, the UK would be asked to pay a gross amount of £55bn, but the net cost could be closer to £15bn after rebates and UK spending have been deducted. A further deduction is likely to come through the UK’s investment in the European Investment Bank. The final figure of the central scenario equates to around £225 per person expected to be living in the UK in 2019, or the approximate amount the UK public sector spends in a week.

Of course, the final figure will hinge upon negotiations, revolving largely around the nature of the future relationship between the UK and EU – particularly the UK’s participation in EU programmes and agencies such as Europol and the European Defence Agency. Talks will also determine whether the UK will continue to work with the EU on joint development funding or choose to create its own programmes. Currently, the largest portion of the UK’s net contribution to the EU goes towards development funding, particularly in eastern Europe. Trade will also play a central role in exit cost discussions.

Is it Amazon-able?

A particularly warm June helped like-for-like retail sales rise by 1.2%, after slipping 0.5% in May, according to the British Retail Consortium. Summer clothing and outdoor toys helped, consistent with recent interest in leisure activities and pursuits supporting otherwise weak consumer spending in recent months.  Online sales grew by 10.1% in June, ahead of the three-month trend of 8.4%, to account for 22% of total retail sales. No surprise, then, that shares in leading bricks-and-mortar retailers such as Debenhams, Marks & Spencer and Next have all fallen in the first half of this year. Sofa retailer DFS issued a profits warning in mid-June against a “market-wide” lack of demand. Since then, five of the ten most shorted large-cap stocks in the London market have been major retailers.

Supermarkets including Tesco and Sainsbury's have admitted that inflation is creeping back into the market, despite their efforts to negotiate with suppliers. Store prices are climbing to offset the weaker pound. Big grocery chains are expected to perform better if there is another spending downturn: will households will rein in their eating out habits in favour of cheaper dining at home?

Bricks and mortar – a Brexit-beater?

House price growth slowed further in June, but political uncertainty at home has weighed more heavily on the sector than Brexit fears, says the Royal Institution of Chartered Surveyors. Domestic politics is seen as having a more direct impact on disposal income, stamp duty and interest rates. Prices are still rising, but the balance of RICS member estate agents across the UK seeing increases rather than falls slipped from 17% to just 7% last month. Nonetheless, most commentators still believe the medium to long term outlook is positive, supported by the inevitable growth in housebuilding to satisfy a chronic shortage. 

A year on from the 2016 property fund liquidity crisis, managers are more sanguine about prospects. Having set aside more cash – 25% of total assets in many cases – to cushion against withdrawals, institutions are resigned to lower returns in a market that is still rising with support from global Ultra High Net Worth private investors. Knight Frank says the UK is still the top choice for this capital, followed by Germany, the US and France. Why? Weaker sterling is clearly key, but also the diversity of opportunities and sizes, combined with transparency and relatively easy execution of transactions. Looks like they’ll keep buying.

Altrad gushes over oil services

Has a clever investor spied a light at the end of the tunnel for the stricken oil services sector? Syrian-born French billionaire Mohed Altrad’s eponymous construction firm is paying £332m – a healthy premium – for UK listed Cape, which works for oil refineries, offshore rigs, LNG plants and power stations across the UK, Middle East, Australia and Asia. The willing target talks of a positive long term outlook, while accepting challenging conditions in the next couple of years, especially pricing pressure and slow payers in the Middle East.

Support services firms in the oil and gas market - which have ben squeezed by clients looking to drive down prices - have seen major consolidation, including Wood Group’s £2.2bn takeover of Amec Foster Wheeler earlier this year. The negative effects of low oil prices arrive far quicker than the benefits. The services sector, a disparate spread of companies, is no stranger to cyclical prices, but for those businesses aiming to remain independent, operational change will be the key to survival. Investment in new projects will not come before there are clear signs of long-term price stability.