The general election result was supposed to be a foregone conclusion. The Conservative party was meant to increase the size of its majority, with opinion polls showing a lead of as much as 18 points over the Labour party in the last month.
However, a surge in support for Jeremy Corbyn has meant that the Conservative lead has narrowed. Some polls are even predicting a hung parliament, which could lead to a period of political instability. Given the already sizeable uncertainty which exists surrounding Brexit, a hung parliament could mean investor sentiment towards UK-focused stocks suffers a sharp decline in the near term.
Therefore, buying a company such as PZ Cussons (LON:PZC) could be a shrewd move. It offers significant geographic diversity and is not overly reliant on the performance of the UK economy. This means its earnings could benefit from any weakening of the pound. It also trades on a lower valuation than other global consumer goods companies, while the growth potential of the emerging world could push its profitability and share price higher over the long run.
Political risk
While it seems highly unlikely that the Labour party will win an outright majority, the party seems to have momentum at the moment. This means that a hung parliament is becoming increasingly likely, which could pose significant challenges for UK investors in the short run.
The likely outcomes of a hung parliament would either be a minority Conservative government, or a deal between either the Conservatives or Labour to govern alongside the SNP. Both of these outcomes would be likely to cause a decline in investor sentiment in the short run, since they could create a relatively weak government. Passing legislation on Brexit and other issues would be tough for a minority government, while the prospect of an Independence referendum in Scotland could be a prerequisite of a coalition involving the SNP. This may lead to yet more political instability and risk over the medium term.
The effect of a hung parliament or minority government on the prospects for the UK economy could be negative. Already, UK consumers face falling real disposable incomes due to CPI inflation surpassing wage growth. The prospect of indecision regarding Brexit or of another election in the short run could lead to consumer, business and investor confidence in the UK economy ebbing away. This could cause declining profitability and falling share prices for UK-focused companies.
Global opportunity
The risk to the UK economy from the election result means that buying globally-focused companies could be a sound move. Not only will they be less exposed to a potential decline in the growth rate of the UK economy resulting from elevated political risk, they could even benefit from a weaker pound.
As has been the case since the EU referendum, the pound could weaken if the election results in a hung parliament. Confidence in the UK’s economic outlook has deteriorated since June 2016 and this has already caused a depreciation in the value of the pound of 13% versus the dollar and 11% versus the euro. Should the UK’s political and economic outlook be subject to more uncertainty, sterling could weaken yet further and create a foreign currency boost for global stocks such as PZ Cussons. It reports in sterling, but relies on the UK for only a minority of its sales.
Sterling could weaken yet further and create a foreign currency boost for global stocks such as PZ Cussons.
As well as the potential for a foreign currency translation boost, PZ Cussons also has exposure to fast-growing markets across the emerging world. Two-thirds of the company’s sales are derived from Asia and Africa, where rising wealth levels have encouraged growing consumer spending.
This trend looks set to continue in the long run, with PZ Cussons having well-established brands through which to capitalise on the growth opportunity. Its presence in a variety of markets has been enhanced through a three-year transformation strategy which has now been completed. This has allowed the company to deliver a faster brand development pipeline, while efficiencies in areas such as IT have also created a stronger business which is better set-up for long-term growth.
Valuation and risk
While PZ Cussons has a diverse geographic footprint, its most important market is Nigeria. Although in the long run the Nigerian economy has growth potential, in the short run it looks set to experience a continuation of the economic difficulties which have been present in recent years. For example, Nigerian consumers have been under significant inflationary pressure and this has led to a requirement for ongoing changes to relative pricing. Further, exchange rate volatility and liquidity have made trading conditions more difficult in Africa’s largest economy.
However, the risks from continued difficulties in Nigeria appear to be priced in. PZ Cussons has a P/E ratio of 19.6, which is lower than the P/E ratios of sector peers such as Unilever and Reckitt Benckiser. Their P/E ratios are 27.6 and 26.4 respectively. Therefore, while PZ Cussons may not be cheap on an absolute basis, its relative valuation shows it could record share price growth.
Outlook
The general election’s result now seems more uncertain than ever. A hung parliament cannot be ruled out, and this could cause significant uncertainty for investors in the short run. Stocks with global exposure could therefore be worth holding, since they may offer greater resilience against potential downgrades to the UK economic outlook, as well as the potential for positive currency translation.
One such stock is PZ Cussons, with its exposure to the emerging world offering bright long-term growth prospects. Although the performance of the Nigerian economy continues to weigh on its overall financial outlook, the company’s relatively low valuation means it could offer significant capital growth potential in the long run. It has also made changes to its business model that have strengthened its growth profile. Therefore, whatever the result on Thursday, it appears to be a sound investment for the long term.