Many UK stocks have taken a hit in recent weeks. In fact, the FTSE 100 is down 5% and the FTSE 250 is down 7%. The market tanked after the new chancellor announced his unfunded plans to cut taxes and enhance spending. Among other things, this means the government will have to borrow from international lenders.
And, of course, the notion that the government would have to borrow from international lenders made the pound weaker. There are also concerns the tax cuts will be inflationary, which, in turn, will increase the government’s debt burden as around a quarter of its debt is inflation linked. None of this is good for the pound.
However, some UK-listed stocks can benefit from a weaker pound, namely those that earn the majority of their earnings overseas. In fact, companies in the FTSE 100 derive approximately 75% of their revenues overseas.
Before the pandemic, around 40% of Burberry‘s (LSE:BRBY) sales were from China, or Chinese tourists buying abroad. The company also generates a lot of its revenue in the US. In fact, a very small percentage of the London fashion house’s income comes in the form of British pounds. The yuan and the dollar have both gained considerably on the pound this year and this should lead to inflated GBP earnings for Burberry.
The weakness of the pound could also push costs up however, as some of Burberry’s production facilities are located in northern England. While some raw material costs might be increasing, at least labour costs should remain unaffected by exchange rate fluctuations.
High fashion also tends to be fairly bombproof when recessions come. This is because the uber wealthy tend to be insulated from economic challenges. And this is a positive characteristic for the brand with economic growth slowing around the world.
I don’t own Burberry shares but I’m looking to add the stock to my portfolio soon as it should benefit considerably from a weaker pound and I appreciate its defensive qualities.
Diageo (LSE:DGE) owns 200 drinks brands, selling in more than 180 countries. In 2018, the US represents over a third of Diageo’s net sales and almost half of its operating profits. And that’s positive as the dollar really is king right now.
In fact, the company makes approximately twice as much income in North American markets, where currencies have stayed strong, than in Europe, including the UK. But like the pound, the euro has been pretty weak this year.
And at the beginning of 2022, Diageo said a strong pound had negatively impacted earnings. But back then, the pound was worth around $1.35. Right now, with the pound at $1.11, it’s going to have a positive impact on earnings.
Once again, a weak pound could push production costs up, but the impact of currency on sales should more than make up for it.
I’m looking to add Diageo to my portfolio soon as I see it benefiting from a weaker pound over the next year. I also like the group as it owns many well-known brands, including Johnnie Walker, Guinness, Baileys, and Smirnoff — giving it defensive qualities. Brands tend to outperform other products even when the economic situation gets tough.
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James Fox has no position in any of the shares mentioned. The Motley Fool UK has recommended Burberry and Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2022