The outlook for the UK economy has deteriorated following the EU referendum. While a recession isn’t guaranteed, it’s certainly on the cards. Therefore UK-focused companies such as BT (LSE: BT.A) could endure a highly challenging period, with their top and bottom lines likely to be hurt to at least some degree by a dip in consumer confidence.
This comes at a crucial moment for BT. It’s in the midst of a major restructuring that’s seeing it ramp-up its offering as it bids to dominate the quad-play market. For example, it has acquired EE, invested heavily in its superfast broadband network and bought up the rights to several major sporting events such as Champions League football. While this strategy could work, it brings additional risk since BT is investing now for potentially higher rewards in the long run.
With BT trading on a price-to-earnings (P/E) ratio of 13.4, it seems to lack a sufficiently wide margin of safety given the uncertain outlook for its business. Furthermore, earnings are due to fall by 11% this year and while a 30% decline in its share price may not occur, BT seems unlikely to beat the wider index in future.
Risky but rewarding?
Also offering high risk is Premier Oil (LSE: PMO). The North Sea-focused oil producer could be subject to major asset impairments and a share price fall of over 30% if the price of oil declines over the medium term. While this may not be likely following its recent recovery, there’s still an imbalance between demand and supply that looks set to continue over the coming months. And with Premier Oil due to be lossmaking in the next two years, its financial outlook is already somewhat downbeat.
However, Premier Oil continues to make strong progress as a business. It’s becoming increasingly efficient and as its latest update showed, it’s performing in line with expectations. Furthermore, the integration of the Eon assets is progressing well. And with production set to be at the upper end of previous forecasts, investor sentiment could continue to improve following its 48% share price gain since the start of the year. Therefore while risky, Premier Oil also offers significant potential rewards.
Defensive potential
Another company with relatively high risks is pharmaceutical specialist Shire (LSE: SHP). It recently decided to merge with Baxalta and while the combined entity could offer superior growth prospects compared to Shire on its own, there are concerns among some investors that the two companies will ultimately not prove to be a strong fit.
Clearly, the market is pricing-in a degree of disappointment, since Shire offers a wide margin of safety. For example, it has a price-to-earnings growth (PEG) ratio of just 0.8, which when its treatment pipeline is taken into account, indicates that there’s 30%-plus upside on offer over the medium term. That’s especially the case since Shire is less dependent on the outlook for the economy than is the case for most stocks and so could be seen as a useful defensive option by nervous investors.
