There’s just one day to go until UK voters decide whether to leave the EU or remain in, and investors are braced for chaotic market conditions.
If we vote to leave the EU, markets could fall sharply, as investors try to guess at the impact a Brexit might have on UK businesses. If we vote to remain in the EU, then a sharp rally could follow.
I suspect most of us own some stocks that will be affected by tomorrow’s referendum result. I know I do. That’s why I’ve also been focusing my attention on identifying companies that won’t be affected by a Brexit.
In my opinion, owning shares in these firms should provide a natural hedge to the outcome of the referendum. Whatever happens, I believe business will continue as normal for these firms. Indeed, I’d argue that any dip after the referendum results could be a good buying opportunity.
Play safe with sin stocks
Diageo (LSE: DGE) and British American Tobacco (LSE: BATS) are not the cheapest stocks in the FTSE 100, but they do offer a number of advantages for investors in uncertain markets.
Diageo and BAT sell to customers all over the world. The UK accounts for a relatively small portion of global sales and profits. Customers of these ‘sin businesses’ tend to be loyal to their chosen brands — and in BAT’s case, addicted.
Shares in Diageo are now down by about 10% from their 52-week high. The firm’s forecast dividend yield of 3.3% yield is still lower than the FTSE 100 average of 4.2%, but Diageo’s payout offers investors a crucial advantage.
The FTSE 100’s dividend yield is only covered 0.7 times by the collective earnings of the companies in the index. That suggests dividend payouts could fall. In contrast, Diageo’s 3.3% forecast yield is covered 1.5 times by forecast earnings. Recent history suggests that Diageo’s payout should also be covered by free cash flow, making it doubly safe.
Similarly, BAT’s 3.9% forecast yield is expected to be covered 1.4 times by earnings this year. The firm’s payout has consistently been covered by normalised free cash flow for at least five years, reinforcing the quality of this payout.
In my view, Diageo and British American Tobacco could both be attractive and low-risk income buys.
What about the oil market?
Even if the UK does vote to leave the EU, there doesn’t seem to be any reason to expect a major global downturn that might hit oil demand. Indeed, I’m fairly confident that falling oil production and rising demand means that the oil market is now starting to recover.
The management of Royal Dutch Shell (LSE: RDSB) have made maintaining the firm’s dividend — which hasn’t been cut since World War 2 — a top priority. The firm’s shares currently offer a forecast yield of 7.1%.
This high yield implies that the market is pricing in a cut. One likely reason for this is that Shell’s expected payout of $1.86 per share isn’t covered by 2016 forecast earnings of about $1.17 per share.
For now, Shell is reliant on asset sales and debt to fund its dividends. Personally, I think the dividend will be maintained. That’s why I’ve expanded my own holding in Shell over the last year, and have no intention of selling ahead of tomorrow’s referendum.