Brexit's Impact On Canada: The Puck May Bounce Off The Board

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Summary

Canadian corporations are not immune to Brexit's fallouts.

Canada's economy is still very dependent upon that of the U.S., and its ability to weather the storm ahead will depend on the reaction of the North American market.

Some Canadian corporations and sectors will be particularly affected, for better or worse.

Uncertainty is never greeted with enthusiasm by financiers of the world, and one could not have expected it to be any different about the 5th greatest economy leaving the European Union and its huge, free and well regulated market. Especially when no road map is drawn for the journey out and article 50 of the 2007 Lisbon Treaty serves as the only compass…

When it comes to Canada however, it is worth noting that Brexit's fallouts should be felt more as a ricochet effect than a direct blow. This is due to the relative modesty of its economic ties with the United Kingdom and the overwhelming influence of the United States' clientele and investments over the Canadian market. For instance, should the greenback serve too long as a refuge currency for investors fleeing the pound sterling, a slowing U.S. economy would result in fewer imports of Canadian merchandises and fewer American investments abroad. Further harm could also come from the West: a weaker European Union could cause turmoil in Asia, which would also hurt U.S. enterprises.

Some direct effect will obviously be felt north of the border too, if only because Canada spent years negotiating a trade agreement with the European Union, the CETA, which is currently under review. Starting over for the sole market of the U.K. could result in the loss of numerous commercial opportunities, as such negotiations are prone to drag over quite a long period of times. The level of trade between those two members of the Commonwealth yet is nowhere near that of the exchanges made under the umbrella of the NAFTA.

Many more developments must occur before one can properly understand and anticipate the actual effects of Brexit on Canada's economy. While we hold our breath, it is still interesting to highlight how much these effects will depend on the resistance of the United States' economy and to try and anticipate which investments into the Canadian equity market should be most affected (for better or worse).

Canada's economy: an American affair

The dependence of Canada's economy on the United States' market is best revealed under the stunning light of most recent data available on Canadian exports and inbound Foreign Direct Investments (FDI). Such data should lead one to conclude that exposure to the U.K. is not sufficient by itself for Brexit to doom the prospect of Canadian corporations.

The spread of Canadian exports

In 2015, Canada's exports of merchandises to the European Union represented 7.20% of the global volume. 42.29% of this European bound trade was destined to the U.K. (for an amount of C$15,951.7 million)… which only accounts for 3.04% of Canadian exports that year. In nominal terms, these volumes have even decreased slightly in recent years, since Canada exported more than C$18 billion worth of merchandises to the Kingdom in 2011.

This declining trend was not generalized and is even in stark contrast with the 17.32% growth that Canadian exports of merchandises have enjoyed over the same 2011-15 period, increasing from C$446,706.8 million to C$524,068.2 million. That surge can only be partly attributed to China: while the People's Republic increased its Canadian imports by 20.3% since 2011, it was only the destination for 3.86% of all Canadian merchandises exported in 2015 (for an approximate value of C$20 billion). The growth in exportation was actually driven by the usual suspects: the U.S. imported 22.25% more worth of Canada's merchandises in 2015 than in 2011, going from C$328,975.4 million to C$402,177.1 million. With a 76.74% share, they remain by far the largest purchaser of Canadian goods abroad.

A focus on the exportation of Canadian services results in a similar picture: although the United Kingdom was the second importer of such services in 2014, it accounted for a mere 5.54% of the total, far behind the United States' 55%.

FDI into Canada

While the United Kingdom exerts more influence on Canada's economy as an investor than an importer, that influence remains modest when put in perspective with that of American investors

A good measure of FDI which has been used for years by the United Nation's Conference on Trade and Development (UNCTAD) is referred to as "FDI Stocks". That measure is defined by the UNCTAD as the value of the share of a corporation's capital and reserves (including retained profits) attributable to the parent enterprise (this is equal to total assets minus total liabilities), plus the net indebtedness of the associate or subsidiary to the parent firm.

According to Statistics Canada, the United Kingdom was the fourth foreign investor into Canada by measure of FDI Stocks in 2015. Yet it only accounted for 4.46% of the total FDI Stocks that year. It was certainly more than China's 2.68%, but less than the Netherlands' 11.59% or even Luxembourg's 7.92% (the Great Duchy filling its part as a launching pad for other foreign investors). Unsurprisingly, the USA dominated that ranking with 50.45% of all FDI Stocks into Canada. Conversely, the United Kingdom is the second beneficiary of Canadian's outwards FDI Stocks, receiving 9.25% of same in 2015, far below the United States' 44.62% share.

Brexit's ricocheting effect on Canadian corporations

While Canada's exposure to the U.K.'s market does not seem impressive, it would be foolish to conclude that its economy is safe and sound. The British decision to part with the European Union could be felt in many ways representing both risks and opportunities for investors.

The waltz of currencies

The most visible effect of Brexit this side of the ocean probably lies with the resulting strength of the U.S. dollar, as investors fleeing the volatility of the pound sterling seek refuge in the greenback. Its relative value to the loonie is made even stronger by the current slump in commodities prices. The exploitation of natural resources still forms the backbone of Canada's economy, and their decreasing prices pulled by a slowing global growth have dragged the Canadian dollar down since 2014. While it traded at parity with its U.S. counterpart in 2012, the Canadian dollar has remained approximately between US$0.69 and US$0.79 so far in 2016.

Corporations whose stock benefits from a weak US dollar might thus be wary of this situation. Because they use the greenback to purchase merchandises from Asia which are retailed in Canada, the likes of Dollarama Inc. (OTC:DLMAF) and Reitmans (Canada) Limited (OTCPK:RTMAF) would be worth monitoring. Currency volatility can also be a risk management challenge and increase hedging costs for corporations exposed to various international markets: transportation behemoth Bombardier (OTCQX:BDRAF) does a significant portion of its sales in euros, Canadian dollars, or pounds sterling. Conversely, this currencies differential could improve the bottom line of Canadian corporations doing most of their expenditures at home while generating revenues in US dollars… provided there remains enough economic activity abroad to generate such revenues! In that category, Canada's largest printer TC Transcontinental (incurs the majority of its costs in Canadian dollars and has recently completed acquisitions which increased its revenues in U.S. dollars.

A prolonged slump in commodities prices

As stated above, any negative effect Brexit would have on global growth could affect Canada through a prolonged downward effect on the prices of commodities. Among many others, stocks such as TransCanada Corporation (NYSE: TRP), Suncor Energy (NYSE: SU), Baytex Energy Corp. (NYSE:BTE) or Enbridge (NYSE: ENB) would be worth following, either to limit one's exposure to a downward trend or to benefit from a potential purchase at great value.

Specific Canadian exposure to trade with the United Kingdom

Concluding with the obvious, Canadian corporations with strong British ties stand to suffer more than any other from the current uncertainty. If the U.K. is their end customer, these businesses will have to address both the anticipated struggles of Britain's economy and the setback of C.E.T.A not applying to their trade. And if the U.K. is to them but a door to the broader European market, they might have to navigate unknown waters for a long while. The new legal framework under which they will be able to pursue their exchanges beyond the Kingdom's shores will indeed cover a gigantic scope applying the continuous flow of individuals, goods, services and investments between the U.K. and the European Union. Investors trying to project themselves into the future currently stare at a blank sheet instead of the voluminous set of European treaties, regulations and case law which took years to detail and test.

Pharmaceutical Concordia International Corp. (NASDAQ: CXRX) has about 42% of its assets in the U.K. and will "monitor its hedging needs" beyond 2016. Auto-parts manufacturer Magna International Inc. (NYSE: MGA) is also very much involved in the Kingdom and could be worth observing.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.