Weekly Wrap: Measuring the Brexit Effects

Update: Not surprisingly, Hershey has rebuffed Mondelez's offer. Click here for an update from Morningstar senior analyst Erin Lash.

Scott Halver: What Brexit means for the London Stock Exchange, Mondelez aims to make a sweet takeover, and what impact Brexit will have on U.S. capital markets firms--this time on the Morningstar Weekly Wrap.

After the widely unexpected Brexit result last week, the proposed merger between Deutsche Borse and the London Stock Exchange seems less likely to go through, but what does that mean for the London Stock Exchange in the long run?

Eric Compton: We have a couple thoughts on this. We think that one, shares are already priced as if the merger is not going through, so in our opinion the merger represents a free optionality at this point. And two, whether or not the merger goes through, we think the London Stock Exchange is going to be fine. There may be some red tape and some frictional costs in the interim over the next two years, but we really think LSE will be able to adapt to whatever negotiations take place as the exit occurs. From a valuation standpoint, shares are currently trading at roughly GBP 25. Our fair value estimate is GBP 30, so shares are currently at roughly 83% of our fair value estimate. We think this offers investors a decent entry point into what should continue to be a key player in market infrastructure in Europe.

Halver: Mondelez International made headlines Thursday with a $23 billion takeover bid for chocolate-maker Hershey. Does this deal have a chance? Senior equity analyst Erin Lash shares her view.

Erin Lash: Shares of Hershey have popped following news that wide-moat Mondelez has made a bid to acquire the leading U.S. chocolate manufacturer. Mondelez's interest in U.S. chocolate is far from a surprise given that since its tie-up with Cadbury more than six years ago, Mondelez has essentially been locked out of the U.S. chocolate space, given Hershey acquired those rights years ago. 

From our vantage point, the one impending hurdle to a deal is that Hershey is a controlled company with more than 80% of the voting power held by the Milton Hershey School Trust, which depends on Hershey's stable dividends to fund its operations. Our contention is supported by the fact that when Hershey attempted to sell itself in 2002, school alumni, as well as the attorney general in Pennsylvania, vigorously opposed a deal, and we fail to see how this time would be any different. From our vantage point, whether a deal gets inked or not--which is highly uncertain--Mondelez's shares look mildly attractive at current valuations.

Halver: Brexit has long-term implications for U.S. capital markets firms operating in the U.K. and Europe, but what about the near to medium term? Here's senior equity analyst Michael Wong with his take.

Michael Wong: In the near to medium term, we believe that the effects of the Brexit announcement, kind of macro factors, will have greater effect on U.S.-based capital market firms than the actual eventual operational changes that will be needed. Especially since it could take two years for the details of the Brexit to be worked out. In terms of interest rates, if they continue being lower for longer, then that will stall the earnings growth of firms that are levered to hikes in interest rates, such as the retail brokerages. In terms of a strengthening U.S. dollar, that will depress the earnings of firms with significant international operations. In terms of a hit to equity or fixed-income prices, this will lower the assets under management of the investment management firms and could lead to a hit in the trading inventory that is unhedged at the investment banks. While if we were to look at volatility in the capital markets, this will lead to both negative and positive effects. Negative effects with show up in lower underwriting and advisory volumes at the investment banks, while it will lead to positive effects in trading volumes at the brokerages and financial exchanges. We believe that many financial stocks are currently pricing in something close to a recession and that much of the sector is undervalued.

Halver:  Be sure to check out Christine Benz’ article on Morningstar.com on how to give your portfolio a midyear checkup.