Sunday 15 September 2019

EU-UK deal is best hope of Irish shares recovering from a Brexit battering

Fears of a hard Brexit and a fall in global markets have dragged down Irish shares, with prices slumping by almost a fifth this year, writes Dan White

Fears of a hard Brexit and a fall in global markets have dragged down Irish shares
Fears of a hard Brexit and a fall in global markets have dragged down Irish shares

It's been a miserable autumn for Irish-quoted companies with share prices down by an average of more than 12pc over the past three months. With fears of a hard Brexit growing and international equity markets remaining weak, the outlook remains bleak.

On January 23 of this year Irish share prices, as measured by the Irish Stock Exchange's Iseq Overall Index, hit a post-crash high. Unfortunately, that was as good as it got. Since then the Iseq Overall has fallen by more than 18pc, with billions wiped off the value of companies. Most of this fall in Irish share prices has occurred over the past three months with the Iseq Overall down by 12.5pc over the past three months.

So why, with the fastest-growing economy in Europe, have investors turned sour on shares in Irish companies?

Part of the explanation lies in what is happening in global equity markets. In the US, the main market index the S&P 500 and the tech-heavy Nasdaq index have both tumbled over the past three months.

It has been a similar story on this side of the Atlantic with the main London index, the FTSE 100, and the Euro Stoxx 50 Index of the 50 leading eurozone shares also well down in recent months.

So that's all right then, the fall in Irish share prices is merely a reflection of what has been happening elsewhere. Not quite.

Despite a very mature global economic recovery, the prospect of eurozone interest rate increases from the ECB next year, Brexit in the UK and the ever-present risk that the Trump administration's belligerent trade policies will trigger a global trade war, British, eurozone and American share prices have fallen by significantly less than those of their Irish counterparts.

In the UK, the FTSE 100 has shed just over 8pc of its value over the past three months while the Euro Stoxx 50 index is down by just under 9pc over the same period. Across the Atlantic the S&P 500 is down 6.8pc since August while even the battered Nasdaq is down by 'only' 10.8pc.

CRH chief executive Albert Manifold. Photo: Gary O' Neill
CRH chief executive Albert Manifold. Photo: Gary O' Neill

So clearly, with Irish share prices down by 12.5pc, not all of the blame for the price falls can be laid at the door of falling international markets. Clearly at least some of the fault lies with uniquely Irish factors.

When one looks more closely at what is happening in the Irish market an even more interesting picture emerges. The Irish Stock Exchange's Iseq General index, which excludes financial shares, has fallen by just over 11pc over the past three months. While this is somewhat more than the fall in either the FTSE 100 or the Euro Stoxx 50, it is not hugely out of line with what has happened in other markets.

In a small market such as the Irish Stock Exchange, the movement of the index can be skewed, up or down, by a handful of large stocks. This is what seems to have happened over the past three months with CRH, the most valuable company on the Dublin market, having lost 17pc of its value over the past three months.

Another major Irish-quoted company whose shares have fallen by more than the index average is Smurfit Kappa, whose board rejected a €37.54-a-share bid from International Paper last June on the grounds that it was "significantly below the board's assessment of the group's true intrinsic worth and prospects and remains significantly below the valuations set by recent industry transactions".

That may very well be the case, but Smurfit Kappa shares were trading at just €24.08 last week, 36pc down on the price International Paper was proposing to pay.

Shares in Ryanair, perhaps the large Irish quoted company most exposed to Brexit, with almost a quarter of its sales coming from the UK, have fallen by almost 12pc over the past three months and by a massive 29pc since January.

By comparison, both of the major quoted food companies, Glanbia and Kerry, have comfortably outperformed the index, with Glanbia up by 12pc and Kerry by 5pc since August.

It helps that both of these companies have diversified away from their Irish roots with almost three-quarters of Glanbia's sales coming from the United States while 55pc of Kerry's sales are generated in the Americas and Asia-Pacific.

It's a very different story with financial shares. The Iseq Financial index is down by 30pc from its January 26th peak and by 20pc over the past three months. Both of the main banks, the main components in Iseq Financial, have taken a hammering this year. The AIB share price peaked at €5.80 on January 29. By last week it was trading at just €3.75, a fall of 35pc. Most of this fall has occurred in the past three months, with the AIB share price down by 22pc since August.

It's a similar story at Bank of Ireland with the share price down 30pc from its January 26 peak of €8.15 to just €5.73 last week.

Once again, most of the fall in the Bank of Ireland share price has taken place over the past three months, with the shares down 21pc over this period.

Likewise the other Irish-owned bank, Permanent TSB, whose share price has fallen by 15pc over the past three months.

So why have investors soured on the Irish banks? All three of them recently issued relatively positive trading statements, with both AIB and Bank of Ireland revealing that their net lending is likely to be up this year, the first increase in net lending at either institution since the 2008 crash.

While matters weren't helped by the decision of AIB's chief executive Bernard Byrne and its chief financial officer Mark Bourke to announce their resignations within eight weeks of each other, investors main fear about the banks has been the possible impact of a hard Brexit on the Irish economy.

Already there are also clear indications that this year's lending growth will not be as strong as had previously been expected, while the most recent KBC Bank/ESRI consumer confidence index showed that consumer confidence had fallen to its lowest level for almost four years in October.

"Lending growth has slowed compared to expectations earlier in the year. The mortgage growth figures are not coming through as strongly as had been thought. Some of the banks are running up against the Central Bank's income and loan limits," says Irish Life Investment Managers economist Lenny McLoughlin.

The Irish banks have also found it extremely difficult to capture the benefits of extremely strong economic growth with the ESRI forecasting GDP growth of 8.9pc this year.

Even when the effect of so-called 'Leprechaun economics' are filtered out, the ESRI is still pencilling a 2.9pc increase in private consumer expenditure and a 4pc increase in net current public expenditure for 2018.

Someone seems to have forgotten to tell the banks. "The Irish economy is booming, but the transmission of economic growth into revenue growth by the banks has been lacklustre," says Jonathan Fearon, European equities manager with Aberdeen Standard Investments. It doesn't help that, a decade on from the crash, all three quoted banks are still working their way through legacy non-performing loans.

The good news here is that this process may finally be drawing to a close with AIB holding out the prospect that its NPL ratio will fall to a "normalised" 5pc by the end of 2019.

It may come as little consolation to their shareholders, but the Irish banks are not alone. The Euro Stoxx index of eurozone bank shares, whose components include both AIB and Bank of Ireland, is down by almost a third from its late January high and by 11pc over the past three months. Not alone are many eurozone banks still labouring under the burden of legacy non-performing loans, more than a decade of very low interest rates has wreaked havoc with their profitability.

In the aftermath of previous financial crises, banks were able to take in deposits from their depositors at very low interest rates and then lend them risk-free to their governments at much higher rates by buying bonds.

This interest rate gap was a hidden subsidy that allowed governments to surreptitiously recapitalise the banks.

Not any more. German 10-year bond yields are currently just 0.37pc while even 30-year bonds yield a mere 1.03pc. Any bank relying on this method to recapitalise its balance sheet will be waiting a long time.

So is there any respite from Irish shares tale of woe or will prices fall even further in the run-up to a hard Brexit on March 29, now just four months away? Not necessarily.

Last Thursday's agreement between the EU and the UK on a political declaration on the future relationship between the two sides is the clearest indication yet that, despite the worst efforts of the British eurosceptics, both sides are determined to have some sort of an agreement in place before March 29.

If that happens, and it is admittedly still a very big 'if', then the outlook for Irish share prices could improve very rapidly. "Some sort of clarity on Brexit would be helpful for share prices," says Aberdeen Standard's Fearon.

Irish Life's McLoughlin adds that: "If the [Brexit] deal is passed then the temporary transition period will be implemented until at least December 2020 whereby current trading rules and regulations will remain in place while the UK and EU negotiate a new trading relationship.

"This would then avoid the sudden sharp negative shock to the both the UK and Irish economies after March next year and thus also provide a platform for Irish stocks to recover from their recent weakness."

 

BY THE NUMBERS

12.5pc... How much the Iseq Overall has fallen by over the past three months

17pc... How much of its value CRH, headed by Albert Manifold lost in the last three months

12pc... The decline in Ryanair’s share price over the same period

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