Rolls Royce may stand most to gain from weakness in pound, JP Morgan says

20th Jun 2016 10:38

(ShareCast News) - Rolls Royce might be the UK's aerospace&defence stock which stood the most to gain in the case of Brexit and the weakness in the pound which would ensue, according to analysts at JP Morgan.Unlike the rest of UK A&D stocks, the manufacturer had a large foreign exchange transaction exposure, the broker explained.For the other seven companies in the sector followed by JP Morgan, the FX impact was translation only (defence companies) or almost wholly translation (Meggitt and Senior), meaning that cable only had a relatively modest, albeit not irrelevant, impact on their earnings per share.Rolls Royce's estimated net dollar exposure, in terms of gross US dollar revenues less dollar costs, in 2017, was forecast at approximately $5bn.Hence, every one US cent move in cable had an FX transaction impact on Rolls Royce's earnings before interest, taxes and amortisation of roughly £20m, the broker said.Analysts David H Perry and Malini Chauhan noted how Rolls Royce's hedge book covered nearly five years of net dollar exposure, so cable was unlikley to affect its profit&loss "for many years".Despite that, "it was very possible that a sharp depreciation in sterling (in a Brexit scenario) could have an immediate positive impact on RR's shares", as the stock rallied to reflect the long-term earnings upside from a weaker euro.Perry and Chauhan pointed to historical precedent to back their case up. For example, shares in Rolls Royce rallied in 2009 as the pound weakened versus the greenback following the collapse of US investment bank Lehman Brothers.The sharp depreciation in the euro-dollar exchange rate at the beginning of 2015 was a major reason behind the large share price gains in Airbus and Safran that year, the analysts said.On the other side of the ledger, the positive impact from a fall in cable's value might be offset by the incerased equity risk premium in the UK in the case of Brexit, with the negative impact on economic growth in the UK and many other countries perhaps also weighing on the shares.In the recent past Rolls Royce had also pointed out that Brexit "would limit its ability to plan and budget for the future" and give its US rivals a competitive advantage.