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It’s a day of everything and nothing. Stock benchmarks are going nowhere in particular, the ECB’s consistently haphazard messaging has lifted the euro a bit, and the corporate news is hard to group into any overarching theme other than to say “mostly retail”. At a scoreboard level it all looks like this:

We can always rely on The Hut Group to give us an angle into the session, however. The Manchester-based whey powder, mascara and websites conglomerate today set out terms for its flotaton on LSE’s sub-prime segment. It’ll be raising £920m as previously flagged so the only real news is that KKR will be slotting up to £950m at 500p a share at the first opportunity, which’d give THG a market value of £5.4bn and a free float of about 35 per cent.

As discussed at length in previous sessions, views on THG’s float plan have been somewhat polarised. It seems however that we’re still getting to grips with what precisely THG does.

One rabbit hole you probably don’t want spend too long inside is the market for mystery boxes. LookFantastic, an arguable flagship among THG’s several hundred websites. sells a whole bunch of these. The idea here is that you buy a box at (for example) £15 plus postage that promises “six incredible beauty treats” that are “worth over £77”. The purchase signs the customer up to an auto-renewing subscription that has to be cancelled manually; newspaper website subscribers will probably be familiar with this general concept.

YouTube is stuffed full of unboxing videos, a fair proportion of which are part of THG’s longstanding influencer marketing strategy (though it seems that in the ethically upright world of makeup vlogging, sponsorship is no guarantee of enthusiasm). From watching these videos a trend emerges. Quite a lot of the product delivered that’s not own-brand seems to be from companies THG names as customers of the retail shopfront bit, THG Ingenuity: names like Revolution Beauty, Elemis / L'Occitane and Nuxe (which is backed by THG investor Sofina).

That’s fine! There would be nothing whatsoever wrong with THG Ingenuity customers shifting excess and short-dated stock via THG’s mystery box subscriptions, assuming that’s what’s happening. Subscription boxes are having a splendid pandemic and retailers that find ways to clear surplus stock can be very highly valued indeed.

Acting as a clearance channel for the client base is a slightly different proposition to the image THG Ingenuity puts forward however -- which (to quote Liberum’s recent note) is a “proprietary technology platform and operating ecosystem, providing end-to-end direct-to-consumer platform under a Software as a Service model” that’s “ahead of many of its peers from a technology perspective”. All of that stuff could well be true, but it probably needs backtesting before we start to apply Ocado multiples. For anyone lucky enough to get a meeting over the next few weeks with THG’s shirtless svengali Matthew Moulding, it might be worth trying to get a feel of how much high-margin services revenue is tied to discount channel resale.

Turning to the already-listed stocks . . . Games Workshop, a retailer of enamel paint and satanic idols, has delivered yet another solid update. The shares had calmed down a little in recent weeks on the assumption that looser social distancing would be a hindrance to demand for four-inch orcs, but not so. News of Q1 sales/profit up 15 per cent/61 per cent pre royalties confirms Games Workshop’s customers are in no sense average and has produced a quite big price reaction. Jefferies can summarise what’s been said:

Games Workshop has reported a very strong Q1 update, with revenue growth of +15% coming in well ahead of our expectations (FY flat, H1 -7.5%). Given the high profit drop-through that is a hallmark of the business, Q1 operating profit is c. +60% and we expect to see material consensus upgrades. We retain our positive stance, underpinned by the quality of the business, top line momentum and ongoing potential for forecast upgrades.

Q1 well ahead of expectations... Games Workshop has reported Q1 trading ahead of the Board’s expectations, with revenue of c.£90m vs £78m in Q1’20, representing growth of +15%. Given the shape of FY20, where H1 grew at +18.5% and H2 (COVID impacted) declined by -6.5%, our flat FY revenue expectation reflected a decline of -7.5% in H1 and growth of +9.5% in H2. Clearly, this result is well ahead of our expectations.

... despite the Retail channel still recovering. The statement notes that trading has been driven by strong Online and Trade performances. Indeed, it comes despite the headwind of the Retail channel still recovering from the COVID-19 closures. Although there is no specific commentary, we suspect the success of Warhammer 40k 9th Edition has been an important underpin and has clearly made a strong start.

High drop-through set to drive consensus upgrades. Reflecting the high dropthrough on incremental revenue, the company estimates Q1 operating profit (preroyalty income) at c.£45m, +61% ahead of last year (Q1’20 £28m). This compares to our FY estimate of a small decline. Although management cautions that it is still early in the financial year, the Q1 outcome alone is likely to drive material consensus upgrades. Royalty income (£3m) is also ahead of the corresponding period (£2m).

An early return to the dividend list. Presumably supported by the strong trading performance, the Board has declared a dividend of 50p/share; this comes ahead of our expectations of a return to dividends in H2.

As can Peel Hunt, house broker:

We see a number of reasons for the strong performance.

 Strong product line-up with the launch of Indomitus and Warhammer starter packs at the end of the period, albeit the paint launch also went well last year. Indomitus sold out rapidly and the subsequent made to order product will register as sales in November.

 The appetite for hobbies accelerated in lockdown.

 There has been some pent-up demand with the webstore & distribution to trade only resuming in May, albeit most of the retail locations did not open until the end of June.

 The company has been successfully driving its online presence and hobby engagement, with an increase in the number of active users by almost 40% to over 8m last year.

 Product marketing has become far slicker and more compulsive, both in terms of the product itself and the marketing.

 Social media has been an important driver. The trailer for Warhammer 40k released in May has been viewed more than 2.3m times.

It is too early to be confident that this is a new level of sales performance, given some of the points above. Last year the company delivered sales of £78m in Q1 (which was a record quarter) and £70m in Q2. For now we are assuming that the £90m in Q1 is an elevated level and that each subsequent quarter delivers sales of £70m, hence our new sales forecast of £300m for the year.

Profits were exceptional in Q1, given a high drop-through rate on the incremental sales and the mix shift, with the strong growth in online particularly helpful for the margin. We are assuming that the full-year margin (pre-royalties) is 35%, which implies a margin of 29% for the remainder of the year. This compares to the margin of 30% in Q2 last year, so allows for some cost growth. . . . 

The shares are trading on 31x our new 2021 forecasts, which does not look expensive for a unique business with a global opportunity. We increase our target price to 10,500p based on 35x May 2022E.

Wm Morrison, a supermarket, is down after its first-half update showed profit down 25 per cent, cashflow unusually weak and full-year guidance unchanged.

Among the many moving parts in Morrison’s statement is petrol, which went sub 100p a litre for unleaded first time since 2016. Fuel, a low margin business for supermarkets that’s often used as a loss leader, is nevertheless a big contributor to working capital inflows. When people stop driving those inflows turn into outflows. Things might improve in the second half but given many shareholders own Morrison for cash returns, they’ll need confidence in more than just Morrison’s management to hang around in hope. Here’s Barclays to summarise the numbers:

Key numbers:

· 2Q Retail contribution to LFL: +11.1%, vs Barclays +10.5%, VUMA consensus +9.5%

· Underlying 1H PBT: £148m, vs Barclays £134m, consensus £145m (-25.3% YoY)

· 1H Free Cash Flow: £(228)m outflow, vs Barclays at £(229)m outflow and £244m INFLOW in 1H19/20

· Net debt: £2,802m, vs Barclays £2,802m and £2,458m at 19/20 year-end

· Regular DPS: 2.04p vs Barclays 1.93p (+5.7% YoY)

· Special dividend decision to be deferred to FY20/21 results (as a reminder Morrison had got in a pattern of paying 2p in 1H and 4p in 2H – but deferred a decision for FY back in March) 

First Impression:

· Sales, profits and FCF are all in-line with our expectations, although we question whether the extent of the FCF outflow may surprise some (there was no consensus for this number).

· The FCF outflow of £(228)m was driven in large part by significant headwinds from working capital (which in turn were primarily driven by lower fuel volumes).

· GUIDANCE: £1bn annualized wholesale supply sales target almost achieved; Morrison will start supplying the remaining c240 McColl’s stores during 2H; Morrison has decided not to comment today on £75m-£125m incremental profit target due to the exceptional circumstances created by COVID-19. Update on COVID: Net COVID impact is c£60m headwind on PBT in 1H but this should reverse to be a c£60m tailwind in 2H – giving some assurance that the step-up required to deliver FY consensus PBT (c£430m) may be deliverable.


The Morrison investment case largely rests on cash generation/return – in 1H we have seen a major FCF outflow and the decision on special dividends deferred again. Consequently, we see the 1H statement as net negative. Profit and FCF should indeed be better in 2H (although we question whether fuel volumes will have totally recovered by y/e), but we struggle to see incremental positives in today’s statement. 


Morrison trades on a FY21E PE of 12.1x vs Sainsbury on 10.2x and sector average of 15.0x.

... and Barclays again, from the conference call:

Beyond what we learned from this morning’s press release our main takeaway was the fact that Morrison approximately quantified the fuel impact on cash flows – it noted that the fuel impact on net debt was >£344m in 1H (through working capital outflows (based on lower volumes) and profit (based on lower pricing)). Overall we stick with our first thoughts on this set of results – per se they add nothing to the cash generation / cash return investment case on Morrison and therefore we see the results as disappointing. It is perfectly possible that Morrison sees a much stronger profit and cash performance in 2H but we would wait until early 2021 to start looking ahead to results in March 2021. We reiterate our Underweight stock rating and 180p price target.

And JP Morgan Caz:

Results and outlook ranged within expectations in 1H, with management reiterating previous guidance for business rates relief to broadly offset extra COVID-19 costs in the year. 1H PBT at £148m, -25% YoY, was impacted by a net drag of £62mn (£155m extra costs offset by four-month business rates relief of £93mn). Management guides to c£60mn of net benefit in 2H (c£78m extra costs offset by six month business rates relief of £137mn). This would imply 2H PBT +35% YoY on FY expectations of £432mn, which seems achievable. Net debt increased by £344mn in 1H, £116mn more than a FCF outflow of £228mn (dragged by WC). Given MRW YTD shares resilience (-5% YTD) vs TSCO (-15% YTD) & SBRY (-20% YTD) and current positioning (SI at c4% FF, close to recent lows), we think the odds are for it to correct into fiscal 22/23 earnings that look eventually DD too high.

Discount soft-furnishings behemoth Dunelm is down a bit after in-line full-year results, no dividend, decent current trading figures and no 2021 guidance. None of that’s a surprise, and Dunelm had already flagged strong trading in July and August, so the pullback’s probably just a bit of top slicing. Those of a dramatic bent have the option, however, to blame the bit in the results about stress testing:

The 'severe but plausible downside' scenario is very conservative in assuming a further national lockdown for ten weeks where our stores are no longer in the 'permitted' status and where we are unable to offer our Click & Collect service. We have also assumed that this national lockdown occurs in our peak Christmas and Winter Sale trading period, with all of the Group's stores being required to shut for ten weeks in the event of a second Covid-19 outbreak, on top of the downturn in the economy that is already included in the central case, including potential Brexit-related disruption. Throughout this second closure, we have assumed no government support (other than the current committed rates holiday) and no further reduction in costs beyond the variable cost reduction from stores being closed. During this period, online sales are assumed to continue to operate at a level similar to that seen during the first period of lockdown. In this scenario, once the stores re-open, a period of reduced sales is expected, with full year sales not returning to pre Covid-19 levels until FY23. Throughout this 'severe but plausible downside' scenario, the Group would not breach any of their financial covenants and would not require any additional sources of financing (including any drawdown on the CCFF). 

As a result of the uncertainties surrounding the forecasts due to the Covid-19 pandemic, the Group has also modelled a reverse stress test scenario. The reverse stress test models the decline in sales that the Group would be able to absorb before breaching any financial covenants. Such a scenario, and the sequence of events that could lead to it, is considered to be remote, as it requires an annual sales reduction of c.35% in FY21 in order to breach financial covenants in the three-year period under review, and is calculated assuming no further government support and no significant changes to the cost base.

... all of which would suggest that Dunelm’s taking a more rigorous approach to this stuff than several banks. Back to the numbers though, and here’s RBC with the detail:

FY20 EBIT was £116mn, in line with our forecast, PBT was £109mn, a little behind our £110mn estimate and EPS was 42.9p, in line with our expectations. Full year LFL sales were down 4.5% yoy (store LFL sales were down 12.7% yoy and online was up 50.5% yoy) and gross margin was up 70bps yoy, helped by sourcing gains, albeit these were partially offset by increased clearance following store closures. This resulted in a 13% yoy decrease in pre-tax profit.

Liquidity remains good, with net cash of £45mn and Dunelm has access to £175mn of approved banking facilities. FCF of £175mn benefited from c.£80mn of exceptional working capital benefits, which are expected to largely reverse in FY21.

Dunelm’s inventory was well down on last year but we don’t think availability gaps are impacting sales, with clear lines into suppliers and 75% of stock with vendors. In terms of FY21 profits and cashflow, we expect the year to be something of a tale of two halves, with significant growth in H1, helped by a further £14mn rates benefit, but no overall rates benefit in H2, and DNLM will also be annualising £14.5mn of furlough benefits in H2. In addition cashflow has benefited by £80mn in FY20 from working capital inflows, which will largely reverse in H2, given the time it will take inventory to rebuild and to pay VAT that has been deferred.

Dunelm continues to gain share on a LFL basis and has recently been able to benefit from the working-from-home trend. As a pure play in UK homewares, offering strong value for money and a very broad range, Dunelm looks well positioned to take advantage of a likely sustained improvement in home-related demand. It is a well-run, cash-generative business, with a net cash position.

However, at c.12x CY21e lease adj. EV/EBITDAR, the valuation looks fairly full for a UK-only retailer and we see potential for some profit taking short term. The main risk to demand in FY21 is regional lockdowns, but the strong homewares trend should sustain a strong sales rate for much of FY21, in our view.

BP’s announced a strategic partnership with Equinor (which we used to call Statoil) to develop offshore wind energy in the US. It’s not all that fascinating except for the fact that speculation was doing the rounds last month about a more extensive tie-up between BP and Equinor.

Could this be a first step to some kind of union? Or was last month’s speculation just cross wires? We’ve no idea. The upshot whichever way is that BP will purchase a 50 per cent interest in both the Empire Wind and Beacon Wind assets from Equinor for $1.1bn subject to regulatory approvals. It’s BP’s first venture into offshore wind and is all part of the Beyond Petroleum v2.0 rebrand under CEO Bernard Looney. He’s hosting a three-day investor day next week to explain it all. In the meantime, here’s Kepler:

BP has ambitious renewables capacity targets by 2025 (20GW) and 2030 (50GW). Those capacity targets are net to BP across solar and wind. BP has 2.5GW of installed renewable capacity (solar in the UK, Brazil, and Spain and onshore wind in the US) and it has already highlighted that it expects Lightsource BP (a 50% JV) to reach 10GW of developed assets in solar by the end of 2023. BP has little experience in offshore wind and it would be interesting to see the mix in renewables capacity (Solar, onshore wind, offshore wind) that BP expects by 2025 and 2030.

On the price paid by BP, we would make the following comment: Equinor has paid USD45m so far to secure the offshore acreage for Empire wind in 2016 and USD135m for Beacon Wind acreage or a total of USD180m. Including the feasibility studies, so far the costs already sunk into those two projects by Equinor amount to just USD210m. The empire wind phase I is partly “de-risked” given the 25-year PPA with New York state.

And Berenberg (hold BP and Equinor, targets 320p and 155nkr):

The projects are still in an early phase, and we believe that limited investment has currently taken place. The price paid by BP appears quite high on that basis, but this is BP’s first offshore wind venture and will enable the company to enter this space, which is set to grow by c20% per year. BP has a target to get to 50GW of renewable power generation capacity by 2030, and offshore wind will be an important part of that growth.

● For Equinor, the deal represents an early monetisation of the lease acquisitions, which will reduce investment required and enable the company to recycle capital into new projects.

● We expect the market will view the deal as a positive for Equinor, demonstrating the value of its offshore wind expertise and pipeline.

● Our price target for Equinor is based on an average of a target multiple of 4.5x EV/DACF for 2021E. Our price target for BP is based on an average of a target multiple of 6.5x EV/DACF for 2021E.

And Barclays:

For Equinor this is a clear positive, highlighting the ability to generate returns on its renewables investment, and also gain a partner that could accelerate the scale of ambitions in the US. For BP, we also see the deal as a positive as it provides an entry point into an obvious missing business in its renewables offering – namely offshore wind. The price paid appears reasonable given the stage of the project and we believe the transaction should fit within the $13-15bn capex budget for 2021 and they also gain an experienced partner. We understand investor skepticism over the traditional oil companies’ ability to create value, yet there is increasing evidence of this and eventually we expect this to be recognized in higher valuations.

Hipgnosis Songs Fund, the song royalties closed-ended investment trust, has announced the acquisition of US-based Big Deal. The buy adds more than 4,400 songs and quite a few new staffers, who’ll sit in a separately managed subsidiary of the listed group, which itself is managed remotely by “investment advisor” Merck Mercuriadis. Why the group needs to subdivide into more factions than UB40, and how shareholders benefit from sitting midway up this trifle structure, are not entirely clear.

There’s no headline price tag on Big Deal, with Hipgnosis funding everything with the remaining C-share capital raised in a July issuance plus another 17.6m ordinaries at 120.65p apiece Somewhat irritatingly, Hipgnosis said on Wednesday that 82 per cent of its C-share issue had been used up but that included this acquisition so it’s impossible to back out the final value. Okay, but what exactly have they bought? Here’s Cazenove (“overweight”, no price target):

Since Big Deal’s inception, it has created and acquired a catalogue of over 4,400 songs written by over 160 songwriters from which it is now producing stable and predictable revenue. The catalogue includes songs that have won five Grammies, 126 NMPA, BMI and ASCAP awards and 27 RIAA Certifications. Some of the best known include Shawn Mendes ‘Stitches’, Panic at the Disco’s ‘High Hopes’, One Direction’s ‘Story of My Life’, Niall Horan’s ‘Slow Hands’ and St Vincent’s ‘Masseduction’, all of which are already represented in the portfolio.

Big Deal also has a US administration function through its Words and Music brand. This will also be rebranded as Hipgnosis Songs Group. Words and Music administers the Big Deal catalogue as well as several third party catalogues. The ability to do more in house is expected to benefit SONG by giving greater control of, and reduced, third-party admin costs, faster collection of royalty income, and bring direct relationships with Digital Service Providers (ie Spotify, Apple et al), which improves SONG’s negotiating position.

. . . . uh, great?

While Big Deal will bring in higher revenues from its song portfolio and administration activities, SONG will also bear additional overheads, though publishing EBITDA margins should be around 30%. But aside from the existing business, Big Deal will bring direct administration expertise for SONG, which will enable it to collect revenue more effectively across the whole portfolio and improves the alignment of interest between stakeholders. Big Deal also supports new songwriters, and SONG will invest up to 5% in supporting new writers through advances limited to 5% of gross assets. These are typically repaid from future royalties. Overall, we believe this deal transforms SONG by bringing additional expertise in-house enabling it to deliver on its promise of actively managing its portfolio by placing songs and collecting revenue more efficiently. We expect to learn more at tomorrow’s capital markets day.

Elsewhere in sellside. Citigroup upgrades Rio Tinto, the mining company and enemy of God, on the back of stronger-for-longer iron ore.

While we expect a modest price pullback in the iron ore near term, we now forecast benchmark iron ore to stay in a range of US$100-$120/t for the balance of 2020 (averaging $100/t for 2020, up from $90/t previously), given that ongoing strength in China now drives a more broadly balanced seaborne market (versus a notable surplus, previously). We also lift forecasts for 2021-23 based on a more constructive Chinese steel demand outlook, expecting iron ore prices to average $90, $80 and $75/t (from $60-65/t) in 2021/22/23, respectively . . . 

Upgrading Rio to Buy

We upgrade RIO to Buy (from Neutral), given potential of strong earnings and cash generation from higher iron ore prices eventually translating into higher shareholder returns, and increase our target price by 15% to £53/share from £46/share. Our DCF valuation increases by 20% (to £52/share) on higher LT iron ore price of US$60/t. FY20/21 NPAT are revised higher to US$11.1b (+16%) and US$12.5b (+55%) respectively. We also open a 30 day positive Catalyst Watch as iron ore prices could potentially stay higher for longer leading to mark-to-market earnings upgrades into the year end.

Strong balance sheet can support higher cash returns

We believe RIO shareholders can benefit from strong balance sheet coupled with high leverage to iron ore pries driving near term cash generation (FCF>9% over next 3 years). We see a further potential for special dividends (not in our base case but assuming a 15% gearing level can release additional ~US$9.5b in dividends for a potential FY23 additional dividend yield of 9%).

Capital allocation

RIO has clearly articulated its capital allocation priority – sustaining capex > ordinary dividend > further capital mgmt./growth/debt mgmt. No debt target and comfortable with zero net debt as well. Dividend policy remains at 40-60% of the underlying earnings. In periods of strong earnings and cash generation, RIO can supplement the ordinary dividends with additional returns to shareholders. With this framework in mind, we believe RIO can afford an 80% payout over next three years (~8% yield) before reverting to upper-end of the policy range (60%).

• Updates might follow, influenced or otherwise by requests and complaints in the comment box.

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