2 share ideas that could benefit from a falling pound

Since December 2021, the Bank of England has raised the interest rate from 0.1% to 1.25%.

The idea is as rates move higher, people should save more, borrow less and demand for goods will fall. This in turn should help bring down the eye-watering prices we’re currently seeing.

But moving interest rates also impacts the attractiveness of a country’s currency. In theory, and all being equal, raising rates should increase the value of a currency. That’s because foreign investors will demand more of it as they can earn a higher rate of interest.

Why then, have we seen sterling weaken over the year against a broad range of currencies?

It boils down to how exchange rates work. An exchange rate is a relationship between one currency and another. So, it’s not just one country’s interest rate policy that matters, it’s the two sides relative to one another.

Compare sterling to the US dollar. Over the year so far, sterling has dropped 9% versus the US dollar.

Both countries are facing similar issues with high inflation and a weak outlook for the economy. In response, central banks have been raising rates. However, the Federal Reserve in the US has taken a much more aggressive approach and markets expect that to continue. That’s contributed to the US dollar strengthening versus the pound.

Central Bank Base Rate UK vs US (%)

Source: Refinitiv Eikon, 22/06/22.

How can investors benefit from weaker sterling?

For investors who are investing in overseas shares with sterling-based accounts, a falling pound is arguably good news. The value of those investments has been boosted in sterling terms.

For example:

Company A generates $100m in profit and the current exchange rate is £1 = $1.2. In sterling terms, those earnings are worth £83m. If the pound weakens vs the dollar and £1 = $1.1, those earnings are now worth £91m.

The same principle applies to UK companies who generate revenue in other countries, but report in sterling. All being equal, a weaker pound would mean higher sterling revenue.

Here’s a look at two UK listed companies who earn a lot of their money overseas.

This article isn’t personal advice, if you’re unsure whether an investment is right for you, seek advice. All investments can fall as well as rise in value, so you could make a loss.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Antofagasta

Antofagasta runs a range of copper mines, mainly in Chile. The group extracts, processes and markets the raw material, which is then shipped off to buyers, most of whom are in Asia.

99% of group revenue comes from outside the UK, with the majority in US dollar – providing a built-in hedge if sterling comes under pressure.

Revenue by geography

Source: Refinitiv Eikon, 23/06/22.

It's a simple business model, the main driver of returns being the price of copper. That focus adds risk, and history tells a story. The copper price crash from 2015-16 coincided with a near 40% drop in share price.

Conditions are more favourable now and last year the group saw around a $2bn revenue bump from a 47% rise in the copper price. That’s fed into higher shareholder returns.

The group’s policy aims to pay a minimum of 35% of underlying net earnings. Though generous conditions mean, for the last two years, it’s paid out 100% – with total dividends of £711m last year. That’s been underpinned by low production costs of $1.20/lb, compared to a selling price of $4.37/lb.

Costs are expected to grow this year. But even the expected $1.55lb, gives plenty of room to make money at current prices and supports the 5.4% prospective dividend yield. Remember though, shareholder returns are never guaranteed, and yields are variable.

Strong cash generation means the balance sheet’s in a strong position. Net cash at the end of the last financial year stood at £540m, marking the first time the group’s had net cash on the books since 2013.

Moving forward, focus is rightly on maintaining production volumes. That means investing in existing mines and making sure they have long enough lifespans to keep the copper flowing. Of the group’s two main sites, one has 42 years of life left and the other 13. Just shy of $3bn in capital expenditure has been planned over the next couple of years, to add another 15 years of life to the latter.

Commodity prices are typically cyclical in their nature, so ups and downs are to be expected. Longer term, there’s plenty of reasons to like copper. It’s the most widely used metal in energy generation and storage. That puts it right at the heart of the global energy and decarbonising revolution, giving a long-term demand tailwind.

For investors looking for a high portion of overseas income and exposure to copper, Antofagasta offers a strong proposition. Trading on a forward price to book ratio a little above the longer-term average, there’s added pressure to deliver.

View Antofagasta’s latest share price and how to deal

British American Tobacco

British American Tobacco (BATS) makes up more than 4% of the FTSE 100 by market capitalisation. That puts it among the ten largest companies in the UK. But while it might be a giant in the UK market, over 99% of its revenue is generated overseas.

Having a hefty overseas portfolio is one of the group’s key strengths. Traditional tobacco demand has been falling in most developed markets for years. Growth in those areas relies on squeezing more revenue from less consumers, that means higher prices – but there’s a limit to how long that can last. Established emerging market exposure gives the group access to areas where tobacco volumes are expected to grow, not fall.

BATS also has a strong position in the US, following the acquisition of Reynolds back in 2017. The US is now the group’s largest region by revenue, bringing in just shy of £12bn in 2021 – that’s around 46% of the group total. And it’s a region where BATS’ strong premium brands are grabbing market share. That gives some wiggle room on pricing, which helps margins and is good news for profits.

Ultimately though, growth in traditional tobacco products is going to be hard to come by. The investment case, for now at least, relies heavily on its ability to return cash to shareholders. And that’s a strength.

The group’s expected to see free cash flow north of £8bn in 2022. That covers the 6.9% prospective dividend yield 1.6 times, leaves room for the £2bn share buyback and some in the tank to pay down debt. Remember though, no returns are guaranteed, and yields are variable.

Speaking of debt, it’s higher than we’d like following the Reynolds acquisition. Net debt stands at around £36bn, with the group paying £460m in interest payments last year. Although, net debt has reduced since 2017 at an annualized rate of 6% a year.

Then there’s regulation, a long-standing bugbear and risk for the industry. US menthol is under the microscope at the minute, where there’s talk the US might follow the UK and put a ban in place. Given the dominant position of BATS' Newport Brand, this would be an unwelcome blow.

Regulation also weighs on next-gen products aimed at a health-conscious consumer, like vape and heated tobacco, arguably the industry’s biggest potential growth driver. The US regulator recently banned the sale of e-cigarettes from one of BATS’ competitors. That opens the door to grab market share. But it also highlights the risks ahead given BATS’ products are largely still under review.

Beyond regulation, BATS has a head start in the next-gen product space, with three global leading brands in Vuse, glo and VELO. The New Category division, which houses these products, is yet to make a profit, but revenue’s growing fast and profits are expected by 2025.

New Category Revenue ($bn)

Source: February 2022 Consumer Analyst Group of New York conference presentation slides, *estimate.

Industry and ethical challenges mean the group’s valued at 9.2 times expected earnings, below its longer-term average. If new products can scale, BATS is well placed to capitalise, and the bottom line will benefit if sterling comes under pressure.

However, it’s unlikely to reach previous highs anytime soon, especially as tobacco groups are off the buying list for many ESG conscious investors. The investment case very much leans on shareholder returns.

View British American Tobacco’s latest share price and how to deal

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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