This week’s Article 50 declaration means that the UK is formally committed to Brexit. But many stock market investors are already sitting on comfortable profits as a result of the UK’s surprise decision to leave the EU.
The sudden devaluation of the pound that followed last summer’s referendum has not been reversed. This means that companies which trade in US dollars but report in pounds are reporting significant profit growth thanks to this shift in exchange rates.
Shareholders have already benefitted from these gains, but if exchange rates stay as they are, I believe there could be more upside to come.
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An extra £300m for you?
The UK’s second-largest tobacco group, Imperial Brands (LSE: IMB), said today that it expects “a currency translation benefit on net revenue and profit of about 13%-14%”. That equates to a £300m boost to the company’s post-tax profits.
Conveniently, this offsets the £300m Imperial is spending on improving the marketing of its key brands. Although the two amounts don’t directly cancel each other out in accounting terms, this currency boost does seem to mean that management is able to spend more without cutting shareholder returns.
It’s not all good news
Before we get too carried away, I think it’s worth pointing out a couple of risks faced by Imperial shareholders.
The first is simply that the global market for cigarettes is shrinking. The only way to deliver volume growth is by taking market share from competitors, or through merger activity. In today’s trading statement, Imperial reported “deterioration in industry volumes” during the first half of the year. Pricing and the mix of products sold were reported to be flat on last year.
Despite this, it expects half-year and full-year profits to be in line with current guidance. This puts the stock on a forecast P/E of 14, with a prospective yield of 4.5%. Those are reasonably attractive figures, but my reading of the company’s commentary is that profits might be falling without the benefit of the weaker pound.
I’d continue to hold Imperial for its dividend income, but I wouldn’t rush to buy more at current levels.
This small-cap looks more exciting
Small-cap ingredients manufacturer Treatt (LSE: TET) is also enjoying double-digit profit growth. But unlike Imperial, Treatt isn’t depending on the weak pound to boost profits.
In a trading update on Thursday, management upgraded full-year earnings guidance for the second time in just two months. “New business wins and a strong performance across all our categories” are expected to lead to earnings above the current forecast level of 17.2p per share, it said.
The firm’s sales growth certainly seems impressive. First-half revenues are expected to be more than 25% higher than during the same period last year. Only 10% of this is down to currency rates, suggesting underlying sales growth of more than 15%.
I estimate that Treatt’s earnings per share could rise by as much as 40% this year. The shares now trade on a demanding forecast P/E of 20 with a yield of just 1.4%. But this profitable and cash-generative company is growing fast and has strong momentum. I’d certainly hold at current levels and would consider using any future dips to buy stock.
