November 22, 2017 / 12:08 PM / 20 days ago

Fitch: Brexit Impact Gradually Mounting for UK Corporates

(The following statement was released by the rating agency) LONDON, November 22 (Fitch) Last year's Brexit vote and subsequent weakening of the pound are beginning to have a visible impact on UK corporates' credit profiles, albeit mainly for leveraged issuers with other significant operating challenges, Fitch Ratings says. Any broader impact on corporate sectors remains dependent on post-Brexit trade terms and the amount of time companies have to prepare for change. The pound's decline was a factor in last month's collapse of Monarch Airlines, as it pushed up dollar-denominated costs. This exacerbated more fundamental operating problems, including competition from low-cost carriers (LCCs), which intensified after terror attacks in Egypt and Tunisia and an attempted coup in Turkey drove more competition on Monarch's key routes to Spain and Portugal. Other airlines' results have also been weakened by the FX move; for example, easyJet on Tuesday reported an adverse currency impact of GBP101 million for the 12 months to end-September. But this is unlikely to have a significant impact on credit profiles. Instead, we believe the key credit risk for airlines is the potential loss of access to the single aviation market, which allows an airline in an EU member state to operate anywhere in the EU. Access is vital for LCCs' point-to-point business models and certainty will be needed well before the planned Brexit date of March 2019 because flights are open for booking months in advance. UK LCCs are establishing new European divisions to operate flights within Europe, but this will not resolve uncertainty over flights between the UK and Europe. Another issuer materially affected by the weaker pound and rising input prices is retailer New Look, which we downgraded to 'CCC' from 'B-' in August. Again, the currency impact, as well as weak pricing power amid subdued consumer confidence caused by rising inflation, is exacerbating other weaknesses. These include high leverage and intense competition from online fashion retailers that have an advantage due to their asset-light operating structures. Inflation has also accelerated in food retail, with food prices rising at their fastest rate since 2013, according to the Office for National Statistics. WTO tariffs in the event of a hard Brexit would further stoke food price inflation, especially if accompanied by additional sterling depreciation, and would lead to (primarily smaller, independent) store closures. Staff costs could also rise if uncertainty about the future status of EU nationals causes some of them to leave prior to Brexit. This has not been an issue for retailers so far, but it has affected care home operators and is a contributing factor in the problems at Four Seasons Health Care (Elli Investments; 'CC'). The company reported a jump in agency nursing costs, which it attributed to a Brexit-related shortage of qualified nurses. This added to existing significant pressures from local authority funding cuts and a rising minimum wage. Other corporate sectors where we see significant Brexit risks include London real estate, which is exposed to the potential loss of financial-sector jobs. While we have not seen signs of a major drop in rents or values, rental terms are becoming more tenant-friendly and flexible, with more and earlier break clauses. Brexit trade terms will also be vital for the UK and European auto industry. A hard Brexit could add around GBP1,500 to the average cost of a vehicle sold in the UK according to industry estimates, which would have the biggest impact on low-margin, high-volume manufacturers. Non-tariff barriers could be an equally big challenge to just-in-time manufacturing models if Brexit leads to frequent customs delays. This is already delaying investment decisions and in the long term could move more auto manufacturing and associated supply chains out of the UK. <a href="https://www.fitchratings.com/site/re/891434">Alternative Brexit Trade Scenarios Contact: Pablo Mazzini Senior Director Corporates +44 20 3530 1021 Fitch Ratings Limited 30 North Colonnade London E14 5GN Angelina Valavina Senior Director Corporates +44 20 3530 1314 Paul Lund Senior Director Corporates +44 20 3530 1244 Simon Kennedy Senior Analyst Fitch Wire +44 20 3530 1387 The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Additional information is available on www.fitchratings.com ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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