Highly indebted stocks may face most Budget risk

<p>The UK Budget will dominate market attention for a large chunk of Wednesday, and it may turn out to be one of the most cautious […]</p>

The UK Budget will dominate market attention for a large chunk of Wednesday, and it may turn out to be one of the most cautious annual economic policy updates for years.

But that doesn’t mean market participants should switch off and go out for a pint as soon Osborne gets to his feet around 1230pm.


The Chancellor of the Exchequer George Osborne now has far more complicated priorities than he did less than a year ago, when the Tories won an unexpected Commons majority.

Osborne is of course the second-highest profile supporter of Britain staying in the EU, after Prime Minister David Cameron.

Osborne also wants the job his boss has, at some stage—and that stage could come after the next general election, if Cameron’s statement last year that he won’t serve a third term is anything to go by.

Thoughts of Brexit risk and his future may therefore combine to make Osborne’s eighth Budget his most stock-market-neutral.



Even so, the Chancellor remains determined to meet 2019/20 targets for the reduction of Britain’s fiscal deficit, especially as the weak trend in basic economic figures looks set to persist.

Therefore, a number of marquee announcements with relatively low economic impact are likely, but a handful may still have potential to boost some equity sectors and bother others.



Oil companies palms greased

  • Fresh tax breaks for North Sea oil producers, totalling £500m, perhaps somewhat more, are possible.  If announced, they would probably be of use to companies with the most modest market capitalisations, suggesting shares of mid-cap oil production, services and engineering firms could get a tailwind.

Shares of producers like:

  • Premier
  • Tullow
  • Cairn
  • EnQuest
  • Faroe and others could be lifted by additional tax relief.


The market might envisage similar benefits for engineers such as:

  • Weir
  • Rotork and ancillary service providers
  • John Wood
  • Amec Foster Wheeler



Stamp of disapproval on buy-to-let

  • Just £600m in further property stamp duty might be raised, if the government moderately ratchets up its programme to raise taxation on residential property investment, as widely forecast.

That might still set certain property-related shares wobbling, with likeliest candidates being estate agents like:

  • Foxtons
  • Savills
  • Countrywide




Tax deductibles deducted

  • One possible government move with bigger potential impact than stamp duty and oil tax breaks could be a clamp down on tax benefits for companies with large debts. 


At the moment, companies are allowed to deduct from their tax bills amounts equivalent to interest they owe on debt repayments.

It is a significant benefit for highly leveraged companies.

The government has been consulting on whether to cap interest deductibles for some time, and the results are likely to be announced by Chancellor Osborne on Wednesday.


A cap of this tax break could be structured to come in at 10%-30% of a company’s Earnings, before Interest, Taxation, Depreciation and Amortisation (EBITDA.)


A rough screen of the largest listed UK companies with the highest ratio of interest payments against EBITDA points to firms with the type of leased property burdens that often go hand-in-hand with considerable debt, including tenanted pub names like the below:

  • Punch Taverns
  • Enterprise Inns
  • Greene King


In the UK, retailers, utilities, Real Estate Investment Trusts (REIT) and some private equity firms have also traditionally been structured to operate with deeper than average leverage.

Here are some of the largest and UK firms with the highest leverage in the above sectors and beyond:

  • AA Plc.
  • Tesco
  • Severn Trent
  • Pennon
  • Cable & Wireless Communications





And here is a snapshot of the Top 20 most-leveraged FTSE 350 stocks.

Judging by the fact that most were trading unchanged when the snapshot was taken, the market was largely discounting any significant impact from reduced tax benefits in the near term…





Please click image to enlarge




…but it seems clear to us that affected firms with relatively moderate enterprise values (say <£1bn) and interest costing between 40%-50% of forecast EBITDA, should expect some negative attention from the market.


Punch Taverns, Enterprise Inns and Greene King, whom we’ve already mentioned fall into this group, as might Tullow, Amec Foster, and others.








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