It's been nearly two weeks since Britain's historic "Brexit" vote that saw residents of the EU giant decide to leave the European Union, and it doesn't look as if the turbulence the vote created is going to calm anytime soon.
There are a number of concerns surrounding the Brexit, but prime on the list is that Article 50 has never been invoked. Since no country has ever chosen to leave the EU before, no one exactly knows what the blueprint looks like. Will it be a quick process, or could it take more than two years? Will EU nations work with Britain, or could trade negotiations be somewhat retaliatory? Can Britain avoid a recession, or is the European Union at greater risk without the support of the U.K.? These are just some of the many questions left to be answered in the weeks and months ahead.
As you might have rightly surmised, negative views on the British economy have been streaming in from financial pundits. Some analysts have called for a mild recession in the U.K. by 2017, while others see more protracted downside from this decision.
However, one path being completely overlooked is that British multinational companies could thrive because of the Brexit. In other words, the Brexit could prove to be bad news for the EU, but for the FTSE in the U.K. it could send stocks to new heights. How? Look no further than the plunging British pound.
British corporate profits could soar because of the Brexit
On the day the Brexit was announced, the British pound had its biggest single-day move in history. In just hours we witnessed a pound that had equated to $1.50 fall to as low as $1.32. In the two weeks since, the pound has marked even lower lows against the U.S. dollar.
On one hand, a falling pound would imply uncertainty with the U.K. economy, which could be construed as bad. But a weaker pound should mean a big boost in exports for U.K. multinational companies that operate overseas. Since U.K. companies report revenue in pounds, when translating from U.S. dollars and other foreign currencies back into a now-devalued pound they're liable to see a double-digit improvement in sales and profits. This is what could power the FTSE higher in light of weakness and uncertainty created throughout the EU.
What multinational U.K. companies might benefit?
Multinational drug developer GlaxoSmithKline (GSK 0.91%) could see a big benefit, with a good portion of its business based in the developed world, where the pound has been punished against other currencies. The boost in sales and profits realized from currency translation couldn't come at a better time for GlaxoSmithKline, either, with the company having completed a business transformation in 2015 that saw it acquire Novartis' vaccine operations and jettison its oncology segment in return. Following years of declining sales caused by Advair losing its patent protection, GSK's earnings could really surprise Wall Street to the upside.
Another U.K. company that could see its profits buoyed is telecom giant Vodafone (VOD -0.27%). Vodafone has found its wireless subscriber growth slowed in Europe and has turned to the faster growth regions of Africa, the Middle East, and the Asia-Pacific region to improve its top-line. Unfortunately, these regions still account for only about a third of Vodafone's revenue. The falling pound should help Vodafone realize improved sales and profits, which could help it reverse its recent weakness.
Keep this important point in mind
Although U.K. multinationals and the FTSE could be primed for surprising success, it's also important that investors keep in mind that currency translation is something businesses can't control. Currencies will fluctuate on a regular basis, meaning the pound could just as easily move higher from here on out and reverse what benefits U.K. multinationals could experience from exports.
What's far more important than currency translation is what these businesses are actually doing on an operating basis. Investors need to be able to cut through the gravy, which is what a falling pound really is for U.K. multinationals, and focus on the meat and potatoes that lie underneath.
In the case of GlaxoSmithKline, its underlying operations have been improving, with or without Brexit. Sales of the company's next-generation, long-lasting COPD and asthma products, Breo Ellipta, Anoro Ellipta, Incruse Ellipta, and Arnuity Ellipta, are finally beginning to ramp up (especially in the case of Breo), and Glaxo's majority ownership in ViiV Healthcare is paying dividends as ViiV's HIV products, which include Triumeq and Tivicay, have been growing by leaps and bounds. In the case of GlaxoSmithKline, the pound's plunge is just icing on the cake to what looks to be a healthy business model.
For Vodafone, things have been more mixed if we look beyond the effects of currency translation. More recently, Vodafone reported its first fiscal year of service revenue and core earnings growth since 2008, but many challenges lie ahead. Vodafone has invested heavily in its network in an effort to draw in more data-hungry consumers, but it's had difficulty in assuaging those consumers to upgrade to higher-margin, but pricier, data plans. With Brexit now a reality, it could be even tougher for Vodafone to encourage consumers to make the switch.
Things could be far better than pundits realize for Britain, but make sure you're digging below the surface and examining the actual operating performance of British multinationals; otherwise, you could be disappointed over the long run.