In Brexit are there only losers? This case study finds BP (and the UK oil and gas industry) will have minimal impact

The dynamics of Brexit vote and their impact on corporate financial risks and return has been studied in a recent article of Pavlos Tarasanski and Shab Hundal.

Pavlos.Tarasanski@jamk.fi) towards the fulfilment of his BBA (International Business)

degree at the JAMK University of Applied Sciences, Jyväskylä. The thesis was supervised by Shab Hundal, Senior Lecturer Financial Management, JAMK University of Applied Sciences, Jyväskylä (Shabnamjit.hundal@jamk.fi). The full text of the thesis is available on

https://www.theseus.fi/handle/10024/132166

Introduction

On the 23rd of June 2016, a referendum took place in the United Kingdom, which paved the way for the UK to leave the European Union (EU) of which it has been a member since 1973. The turnout rate was 71.8%, with 52% voting in favor of ‘Brexit’. The outcome of the referendum was no less than a jolt to the European Union (EU). This decision was unprecedented although the article 50 had allowed the member countries to leave the union should they want to do so.

Needless to say, the UK has been amongst the prominent members of the EU, for example, it contributed to the tune of 12.57% of the EU’s budget in 2015. Due to this very prominence of the UK, many business and political analysts started downgrading the business prospects of the EU and the UK, and others went even further and cautioned that Brexit might have severe ‘socio-political’ repercussions.

The air of uncertainty hovering over Europe prompted to undertake this research project, which aimed to measure and compare the financial effects of the Brexit vote on the UK based five leading multinationals (MNCs) in terms of market risk, return and overall company performance. The selection criteria of the five case companies were, first, the chosen companies should be large-sized UK origin MNCs, and second, each of the case company should belong to a different industry. The underlying assumption was that although the absolute impact of the Brexit vote might be pervasive, however, the relative impact might not be due to the differences in terms of the industry characteristics of case companies. The case companies–industries were: 1) Royal Bank of Scotland (RBS) – banking, 2) Marks & Spencer (M&S) – retail, 3) EasyJet – airline, 4) GlaxoSmithKline (GSK) – healthcare, 5) British Petroleum (BP) – energy.

The study aimed to explore the following research questions:

  1. What are the key financial risks that the case companies are facing?

  2. Has Brexit vote affected the degree and direction of risk exposure, investor expectations, and performance of the case companies?

  3. How can these effects be measured and compared?

The data was collected from three publicly available stock market databases: Yahoo Finance, Investing.com, and Trading Economics. The key variables of study-market risk exposure, investors’ expectations, and financial performance were measured. both pre-Brexit vote and post-Brexit vote, by the beta coefficient, the Capital Asset Pricing Model (CAPM), and Jensen’s alpha, respectively. Two reference periods were taken in the current study, the first one between 03.07.2001 to 23.06.2016, and the second between 03.07.2001 and 19.04.2017. Multinational corporations are not only big but also complex entities, which include their interactions with several markets, different countries, and multiple currencies. Depending on their scale, market power, complexity, and pervasiveness, the investors of such MNCs may attach risk premium accordingly on their expected return for the given level of risk tolerance. The CAPM model, despite its practical limitations, has proved to be a helpful model to estimate how much minimum return investors must expect. The beta coefficient helps to measure the volatility/sensitivity/responsiveness of the stock return with respect to the changes in the market return. Similarly, Jensen’s alpha compares a company’s performance to the overall market performance. Since the sheer scale of uncertainties surrounding Brexit vote has been mammoth and at the same time expected to have significant effects on the investors’ perceptions, risk exposures, and market fluctuations, therefore, the selection of all the above-mentioned statistical measures have been well-reasoned.

Findings

For BP, risk exposure largely decreased, despite Brexit vote being hyped as a game-changing event. Because of the low risk, investors’ expectation did not change much and resultantly BP could manage to sail through the post-Brexit vote phase without any major disruptions in the Financial market. This finding has been in line with many commentators, who would believe minimal effects of Brexit vote on the UK’s oil and gas industry owing to the regulations, controls, and support (especially fiscal support related to taxation) of the UK government. Arguably, the above-mentioned measures might have provided assurances to the investors due to the visible preparedness of the UK government to come for the rescue of its oil and gas industry in the event of any contingency.

The RBS faced a difficult financial situation in the post-Brexit vote period. The company incurred a loss of £7 billion for 2016. Interestingly and somewhat contradictorily, although the market risk of the company went down due to the UK government support to the banking sector in general, nonetheless, investors started placing a substantially high level of the risk premium on the stock price of the RBS and thus raised the bar of minimum expected returns. In other words, investors got so much afraid of the potential banking meltdown in the light of Brexit vote that they started demanding substantial compensation for their investments in the RBS. This finding may also imply that even though investors felt safer with the RBS, they did not want to bear the inherent risk associated with the banking sector in the wake of uncertainties associated with the fallout of post-Brexit vote scenario.

M&S faced turbulent times in the post-Brexit vote scenario. The falling value of the pound sterling could not contribute to the revenue of the company; nonetheless, the burgeoning import bill put a considerable strain on the profitability of the company; consequently, the stock market reaction turned negative. In the wake above-mentioned unfavorable scenario, the board of directors even started contemplating whether it was better to close down some of its stores due to rising prices of inventory and diminishing revenue.

GSK’s case has been particularly interesting because the company operates in the highly uncertain pharma industry owing to its heavy reliance on R&D activities, the complexity of manufacturing and selling medical products, and exposure to variegated legal systems. The findings reveal that the company’s overall realized market performance improved over the expected returns despite its exposure to the higher level of market risk. In other words, investors recognized not only the increasing market risks but also nature and institutional settings, in which the company functions, therefore, they did not put extra pressure on the company.

Lastly, EasyJet has been the least unfavorably affected by the Brexit vote. The airline industry has been booming in recent years and EasyJet has been relatively successful in capitalizing the growth of the airline industry too. Although the risk exposure of the company decreased, however, investors also demand a higher return since they wanted to take advantage of the favorable times of the airline industry. In particular, EasyJet reinvested a significant amount of resources, which raised investors’ expectations albeit the financial performance somewhat disappointing.

Conclusion

Brexit vote has caused several uncertainties to trade and investments between UK based MNCs and the rest of the world, and the early research findings, business commentaries, and other reports are nearly unanimous that the Brexit vote consequences will not be deemed favorable to the UK based MNCs. Interestingly, the findings of the current article in reference to each of the case company are very much relevant even today although the study was conducted in 2016-17. For example, BP has not only avoided the scare of Brexit vote but also has shown its commitment to strengthen its operations in the UK. Similarly, the RBS has already made an addition to the tune of £100 million to its reserve fund, which is created with the sole aim to give positive signals to its investors and clear uncertainties in their minds lest the stock prices plummet even further. Furthermore, the uncertainties shrouding M&S has even thickened, especially those related to the overseas revenue. The market risk exposure of the GSK is very high considering the fall in its revenue and R&D spending. EasyJet is still going gaga due its business expansion and increasing revenue.

Nonetheless, the further research efforts are much-needed in order to cover more dimensions of the Brexit, especially the ongoing uncertainties related to ‘the deal’ or ‘no deal’ speculations and their political ramifications in the UK.

Atso Andersen