OREANDA-NEWS. The depreciation of sterling since the Brexit vote is unlikely to spur any near-term corporate rating actions, but a further 10% decline for a sustained period would magnify the negative effects and increase pressure on some ratings, Fitch Ratings says. UK retailers and airlines are particularly exposed.

Our analysis of an initial sample of Fitch-rated UK corporates considered most exposed found that a 10% sterling depreciation from pre-vote levels, broadly what has occurred so far, would lead to an average increase of 0.5x in unhedged leverage (debt/funds from operations). A 20% depreciation to around USD1.18 or EUR1.06 that was maintained over the long term would result in an average 2.7x increase in leverage. Under this stress case, ratings would be affected if companies were unable to rebalance capital structures or limit FX impacts on the cost of imported goods following the expiry of existing hedging arrangements.

Retailers such as New Look and Tesco are the most exposed to weaker sterling on an unhedged basis in our sample. Tesco, for example, generates three-quarters of its revenue in UK pounds. But nearly half its costs and half its debt are in foreign currency, so cash flow pressures from higher costs of imported goods are compounded by the higher cost of servicing foreign-currency debt, unless there are meaningful compensating actions.

We believe large retailers will be able to source from cheaper locations to help offset the impact. Impacts are mitigated in the short term when FX hedging effects are considered, where companies buy currency forwards to ensure they have access to foreign currency at a fixed rate. Hedging contracts are generally only for the next six to 12 months and after that retailers would have to increase prices, or source from cheaper markets, to protect margins.

New Look hedges between 90% and 100% of foreign-currency requirements shorter than six months and 50% of requirements up to 15 months. Tesco's hedges meaningfully reduce the foreign-currency exposure on its debt and it hedges short-term foreign-currency requirements for its cost of imported goods, in line with market practices.

UK airlines also face a currency mismatch because most of their costs and a large share of their debt are related to aircraft finance in US dollars. For British Airways this is mitigated by around half its revenue being generated in foreign currencies.

Some companies in our analysis benefit from weaker sterling. For example, Thomas Cook's leverage could improve as euro revenues translate into higher sterling profits to service pound-denominated debt. More generally, exporters could theoretically increase their overseas sales. But this assumes more of their products would be required on world markets and they have the capacity to increase production and exports.