Quilter Cheviot budget impact - a sector by sector breakdown - 7th November 2024

Labour’s “tax and spend” budget for “growth” aims to raise £40bn a year in taxes, to partially fund day to day spending. Meanwhile they have tweaked the fiscal rules to allow greater borrowing to fund investment. The net result is a potential increase in spending of approximately £70bn p.a. by 2029/30, funded by an additional £40bn p.a. from taxes and £30bn p.a. from additional borrowing by 2029/30.

The overall economic impact of this budget is estimated by the OBR (Office for Budget Responsibility) to boost economic growth and inflation slightly in the first two years. Any impact on longer-term growth would likely need additional measures. The OBR now forecasts real GDP growth of 2% in 2025 (an increase of 0.5% vs pre budget) and CPI (consumer price index) inflation to peak at 2.6% in 2025. Overall, it anticipates that the policy measures will increase inflation by 0.4% at their peak effect in 2026, as a result of excess demand due to fiscal loosening and some pass through of the NICs rises onto consumer prices.

The higher borrowing requirements and higher inflation forecasts pushed 10-year gilt yields up 5bps (0.05%) on the day of the budget and another 6bps (0.06%) the day after, with a slightly more noticeable impact at the short end of the yield curve driven by a potentially shallower path for interest rate cuts. On the day sterling, a key barometer of political and macro-economic sentiment, was broadly unchanged at 1.30 against the dollar with EURGBP at 0.84.

At this stage, we see relatively little impact from an overall asset allocation perspective coming from the budget. A broad backdrop of slowing but decent global growth with a continued steady normalisation in inflation and interest rates, should support both equities and fixed income versus cash and alternatives over the next 6-12 months. At a regional equity level, we currently have a small overweight to Japan, Emerging Markets and the UK, and as always will review our positions fully at our next asset allocation meeting.

With regards to UK equities specifically, on the day of the budget, we note no particular difference in performance at a headline level between UK mid caps (50% sales revenue to UK) and UK large caps FTSE 100 (25% sales revenue to UK). The AIM market however was up 4% on the day, owing to reassurance that some IHT (inheritance tax) relief was being persevered for AIM assets.

The rest of this report looks in more detail at the potential exposures and impact for UK companies by sector, as a result the more granular changes outlined in the budget.

Banks (William Howlett) The budget is positive for UK banks given no additional bank taxes (there is already the banking surcharge of 3% and bank levy) which had been feared. The additional NI contributions impact earnings by only c. 1%. There is also some better news after the Appeals Court ruling on motor finance commissions had seen weakness for those with exposure (notably Close Brothers and Lloyds), weighing on sentiment more broadly

Aerospace & Defence (Matthew Dorset) An additional £2.9bn of funding was announced for Defence in the budget, representing 2.3% growth in real terms relative to this year’s defence budget. This was higher than expected and further bolstered by the reiteration of the Government’s pledge to spend £3bn pa in military assistance to Ukraine while the conflict continues. The Government has maintained its commitment to increase UK defence spending to 2.5% of GDP when possible. The Strategic Defence Review is ongoing and is expected to be complete in H1 2025, so the commitment to increased spending by the Government in advance of this is positive for the sector. In our coverage, BAE is the most obvious beneficiary given 26% of revenue derives from the UK, while Melrose and Rolls Royce also have some exposure here.

Building Products (Jarek Pominkiewicz) There were lots of discussions that should provide support for the wider building products industry beyond the upside from residential new build. These included the commitment to large scale infrastructure projects including HS2 phase 1, the link to Euston and continued funding of Sizewell C. There was also other non-residential spend, such as the £1.4bn budget to rebuild schools, £1.2bn for more prison places, £1.6bn for road maintenance and new road systems, £1bn to replace reinforced autoclaved aerated concrete and to supplement existing backlog of critical maintenance, repairs and upgrades across the NHS. Travis Perkins’ sales are exposed to new commercial and industrial construction (<20% of group sales) and infrastructure (c4% of group sales), although the impact on sales growth from the above measures is difficult to ascertain.

Consumer Discretionary (Mamta Valechha) Budget not great news for business costs and opex (operating expenditure) inflation. Most retailers had been planning for c.6% labour inflation from April 2025, so the combined announcement of a 6.7% in the National Living wage for over 21 year olds, and an additional 1.2% in employer NI is worse than expected. Unless higher opex costs can be offset by passing the costs on in higher prices and/or productivity benefits, this will lead to lower profitability with lower margins. EBIT impact can range from 2-8% depending on geographic mix and level of automation.

Under our coverage, given their geographic mix and lower exposure to the UK, Compass and JD will be least impacted (~2% of EBIT impact). On the other hand, Greggs remains most affected as labour costs represents 38% of the total, with limited automation and revenues are 100% in the UK. However, we note that Greggs sets prices to solve for opex inflation. Whitbread sees labour cost of 35% of the total cost, changes announced can lead to ~1.8% increase in total cost and a ~5% hit to PBT. Historically, WTB has been good at mitigating costs.

Nothing was said on the restoration of tax-free shopping which is widely felt to have materially impacted tourism and spending across the country since it was abolished in January 2021. Gambling stocks have seen relief. The UK Budget includes no tax rise for online gambling.

Consumer Staples (Chris Beckett) Most of our Consumer Staples coverage are large global businesses where the UK economy and tax details do not matter that much. The exceptions are domestic food manufacturers (that we generally don’t follow or recommend) and food retailers:

The main impact is from the increase in the minimum wage (+6.7%), which together with employers’ NI (13.8% to 15%) materially increases employee costs. This will proportionately impact companies with a large UK employee base (at minimum wage or close to it). At the margin the changes announced yesterday will encourage automation and other efficiency measures.

Food Manufacturers: in many cases the extra costs will need to be passed to consumers via retailers – depending on product elasticities this will reduce demand and employment levels. For some companies (Greencore, Bakkavor etc) if the market doesn’t allow price recovery profits will be materially impacted (c. -10% possible).

Food Retail: For Sainsbury and Tesco NI and Wages represent c. 1.2 -1.4% of grocery sales. It doesn’t sound much but these are high volume, low margin businesses (Tesco UK/RoI margin 4.7%, Sainsbury 3.1%). However, wage pressure is nothing new for these companies and they have been very good at mitigating it. Again, wage pressures enhance the benefits of automation giving a minor benefit to Ocado.

Energy (Maurizio Carulli) The UK government has announced the increase of the windfall tax on North Sea oil & gas producers. The levy was introduced by the previous government in 2022, as a temporary measure to address the “extraordinary profits” of oil & gas companies operating in the UK, following a spike in oil & gas prices. Today the budget has further extended the levy by one year to 2030, has increased its rate to 38% from 35%, and scrapped a 29% investment allowance previously allowing the company to offset tax from capital that is reinvested. It has maintained the decarbonisation allowance.

Whilst we understand the need to raise tax revenues in this budget, and the government’s commitment to further decarbonise the UK economy, we think that the changes will negatively affect the economic conditions of the significant oil & gas industry in the UK. This will make the UK portion of the North Sea a less appetising area for capital investment, and for gas, increase the need for imports in the future. From a tax policy point of view, we note that the reason used to introduce the temporary levy in 2022 (extraordinary profits caused by high oil & gas prices), is now diminished following the lower level of oil & gas prices in 2024.

The impact on profits and valuation for the two UK Oil Majors, Shell and BP, is negligible because they divested most of their North Sea assets years ago. The impact would be more noticeable for smaller listed players like Harbour Energy and Serica. That said, Harbour Energy had already announced in the past that they intend to divest their North Sea assets and Serica that it is looking to expand outside the UK. More important, however, will be the impact on small businesses that are part of the North Sea value chain, from manufacturing to services.

Capital Goods (Jarek Pominkiewicz) Most companies in our UK capital goods coverage are global businesses, although they tend to have some physical presence in the UK as well. That said, our back-of-the-envelope analysis suggests in general limited impact at the operating profit margin level from the increase in employers’ NI rates in the UK (although we acknowledge this will vary from company to company) and the companies should be able to mitigate it through price actions. Wages in the capital goods segment tend to sit above minimum wage, so the increases in minimum statutory hourly pay rates should have limited direct impact on cap goods wage bills.

Housebuilders (Oli Creasey) While the budget commentary for housebuilding was supportive, we expect limited positive impact to housebuilder income statements. The announcements tended to be aimed at supporting affordable housing construction and low-cost loans to small (ie: unlisted) builders.

Regards the affordable housing, only Vistry (not covered) has material exposure to this market. The announcement of additional funding to support the construction of “up to 5,000” new homes is not significant we feel, given Vistry is one of many builders operating in this segment, and is expected to build 18,000 homes on its own in 2024. We expect a negligible impact and make no changes to forecasts as a result of new policy announcements.

Around 25% of housebuilding costs are labour-based, and the increase in NI contributions could negatively impact profits by as much as 2-3%. Builders are not especially well-paid, although large housebuilders already pay above minimum wage and shouldn’t have to increase wages further to stay ahead of the higher level.

The sector share prices are also under pressure as interest rates rise following the budget. Higher interest rates mean higher mortgage rates, which mean fewer buyers can afford homes at current pricing. The second order macro impact may prove to be more significant than any of the Chancellor’s announcements.

Telecoms (Matthew Dorset)

The most direct impact of the Budget on UK Telcos is the increase to employers NI rates. While this will impact both BT and Vodafone, the impact on BT will be significantly larger given the size of its UK workforce at around 71,000 employees. We estimate that this could represent an EBITDA headwind of around –0.5%, all else equal. However, we would note that BT is significantly reducing the size of its workforce (with a workforce reduction of more than 40% planned by 2030, many of which will be UK based) and has effectively cut costs in recent years which will help to mitigate this impact.

More positively, the Government maintained the policy allowing full expensing of capital expenditure and announced over £500m of funding for “improving reliable fast broadband and mobile coverage across our country, including in rural areas”. In our view, this demonstrates a continued commitment to the modernisation of mobile and broadband networks, which suggests a generally supportive environment for Telcos and an understanding of the importance of their investment for the economy. There was no commentary on pricing which is also positive for the sector.

Pharmaceuticals (Sheena Berry) When it comes to the healthcare sector, UK exposure is relatively small. AstraZeneca and GSK both generate less than 10% of their sales from the UK. What goes on in terms of US politics (drug pricing etc) has more impact.

REITs (Oli Creasey) As with housebuilders, REIT share price returns are inversely correlated to interest rates as lower rates create headroom for property yield compression (and vice versa). The bond market’s reaction to the budget has had a negative impact on the sector in terms of expected capital returns although we expect income (which is largely derived from rent) to be largely unaffected.

Source: Quilter Cheviot, Senator House, 85 Queen Victoria Street, London, EC4V 4AB

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