Markets Now - Monday 3rd August 2020
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The FT’s first ever mention of Bytedance, the owner of video silo Tiktok, was in Alphaville. Back in November 2016, FTAV cast a crook eye at Bytedance’s technology stack and mooted $10bn valuation as part of its This is nuts. When’s the crash? strand. Spin forward less than two years and the valuation had risen to $75bn. A year and ten months after that, the actual POTUS is using mafia tactics to break up Bytedance on undefined national security grounds. History is a relentless master.
On this side of the pond there’s a more rounded approach to Chinese diplomatic relations. HSBC -- a ~$91bn valued company that collects data on customers in 64 countries and publicly supports the CCP, having operated in Shanghai since 1865 -- breezed through a half-year results conference call in which politics was mentioned only as an exogenous risk factor. “I’m not going to get into speculating on what actions may or may not be taken between respective governments,” said CEO Noel Quinn. “It’s not my role to do that. At the end of the day, I’m a banker and not an economist or a politician.”
(Peter Wong, the HSBC Asia boss who did a photocall in June to publicly support China’s Hong Kong security law, is also a banker not an economist or a politician.)
In terms of numbers, HSBC’s update was quite bad. Q2 loan impairments were high at $3.8bn, which meant headline profit missed consensus by about 12 per cent, and the full-year impairments range widened from $7bn-$11bn to $8bn-$13bn (consensus: $9.8bn). Revenue, up 1 per cent quarter on quarter, beat forecasts but lower rates meant net interest margin fell 21 bips. Also, the conference call added in a caution, apparently not worth flagging in the statement, that the year-end cost savings target of $1bn won’t be hit.
Shore Capital reckons they’re inching closer to a breakup:
Adjusted PBT of $2,593m (consensus: $2,935m) was down 57% yoy and 14% qoq. The $342m (12%) miss versus consensus primarily reflected negative variances on impairments (-$1,168m) and to a lesser extent income from JVs and associates (-$13m) that was partly offset by positive variances on income (+$366m … of which net interest income was -$40m and non-interest income was +$406m) and costs (+$473m). Versus the prior year comparative, total income reduced by 4% to $13,150m, costs reduced by 7% to $7,262m, impairments increased by 638% to $3,832m and income from JVs and associates reduced by 24% to $537m.
Statutory PBT was $1,089m (consensus: $2,460m), with the main difference to the adjusted number being a $1.2bn write down of software intangibles.
In terms of key metrics:
The net interest margin of 1.33% (consensus: 1.39%) deteriorated by 23bps yoy and deteriorated by 21bps qoq (reflecting the impact of lower interest rates in the UK and US);
The impairment ratio of 1.48% (consensus: n/a) deteriorated by 127bps yoy and deteriorated by 34bps qoq (reflecting a combination of higher single name wholesale credit losses and tighter macro-economic assumptions, notably impacting on the group’s European operations).
The cost-to-income ratio of 55.2% (consensus: 60.5%) improved by 2.1ppts yoy and improved by 2.4ppts qoq (reflecting very good cost control despite the transformation programme being paused due to Covid-19); and
The statutory RoTE (Annualised Ytd) of 3.8% deteriorated by 7.4ppts yoy and deteriorated by 0.4ppts qoq (this is well below the group’s cost of equity which we estimate at c10%).
The group did not declare an interim dividend, as expected, in line with the Bank of England’s requirement that the large UK banks should not make any distributions to shareholders during calendar 2020. The group intends to update the market on its dividend policy at the 2020F year end (previously it had expected to do so before this, which suggests to us that the prospects of a 2020F final have reduced).
TNAV per share of $7.34 (consensus: $7.47) was up 15 cents yoy but down 10 cents qoq (with the miss versus consensus primarily due to weaker than expected profitability and negative movements on own credit due to spread tightening during Q2).
The core tier 1 ratio of 15.0% (consensus: 14.4%) was up 70bps yoy and 40bps qoq (with the beat versus consensus primarily due to lower than expected RWA growth and transitional relief, although we would expect both to be headwinds in H2).
Outlook: The outlook remains cautions given macro (including Covid and lower-for-longer interest rates) and geo-political uncertainty. Full year impairment charge guidance has worsened to between $8bn-$13bn (previously $7bn-$11bn), with consensus currently at $9.8bn (Shore: $8.7bn). There is no detail as yet as to what addition actions the group may take to improve performance, albeit deeper than previously expected cost cutting is likely in Europe and the US and we would not rule out a break-up option being considered.
Forecasts: For y/e December 2020F, we currently forecast adjusted PBT pf $10,682m (consensus: $11,359m), adjusted EPS of $0.27, no dividend and TNAVPS of $7.57. We expect both our forecasts and consensus to move down given the weaker than expected Q1 print and more cautious full year impairment guidance. Thereafter we expect profits to recover rapidly as impairments normalise, with our forecasts seeing adjusted EPS increasing to $0.70 by 2022F (equivalent to an adjusted RoTE of 8.8%). We assume dividends resume in 2021F with a payment of $0.25, rising to $0.35 in 2022F.
Valuation and recommendation: HSBC’s shares have fallen by 42% year-to-date versus a 51% fall in the average share price of the other mainstream UK banks. At yesterday’s closing price of 342p, HSBC trades on 0.61x its trailing (30th June 2020) TNAV per share of $7.34. Our last published fair value of 440p (29% upside) is equivalent to a P/TNAV multiple of 0.79x. Despite the disappointing results and negative outlook and macro-economic uncertainty, the market appears to have already more than priced-in the bad news. Given increasing upside to our fair value, we will need to review whether our current neutral stance remains appropriate. For now we remain at HOLD.
Goodbody’s also thinking about surgery:
1) Overall, it was a marginal beat on adjusted PBT (pre-software intangibles write-down and FX) but the materially higher-than consensus impairments as well as the very cautious outlook commentary outweigh the positives on revenues and costs; 2) Revenues were 3.4%v ahead of consensus expectations for 2Q – NII was marginally behind (NIM of 133bps versus consensus for 139bps) while there was an 8.0% beat on OOI with strong performance in GB&M a key driver here; 3) Costs came in materially below expectations at $7.26bn (versus consensus for $8.15bn) with positive messages in relation to the pace of cost takeout and the trajectory of same – though no radical announcements in relation to retrenchment / relocation actions communicated as some had been speculating ahead of this morning (we thought the conclusion regarding ‘sitting still’ in the Friday Euromoney piece was on the money); 4) ECLs came in at $3.83bn ($2.3bn charge against Stage 1 & Stage 2 loans and a $1.5bn charge against Stage 3 loans) versus consensus for $2.66bn; 5) RWAs were a bit lighter than expected at end-2Q20 ($855bn versus consensus for $879bn) though the company is continuing to guide mid to high single digit % growth in RWAs for FY20 as a whole (due to credit migration, partially offset by structural RWA reduction as capital is reallocated across the Group); and 6) The CET1 capital ratio came in at 15.0% at end-1H20, which is 60bps higher than consensus (with lower RWAs playing a key role here) and the update notes that the dividend will be reconsidered at the stage of the full year results (leading to question marks). Elsewhere, it is worth noting the substantive excess liquidity build, with deposits +6% q/q (implying end-2Q LTD of <67%).
On the UK, it is worth noting that gross lending was c.£9bn in 1H20, with 55% of lending originated by intermediaries (47% in FY19); 90+day mortgage delinquencies were 0.23% (up from 0.16% one year ago); and credit card 90-179-day delinquencies picked up to 0.88% (up from 0.59% a year ago). The report picks up on UK NIM pressures as well as significant growth in average UK deposits – while the CFO has just spoken about the share growth that HSBC UK has experienced again YTD (BBLS, etc.) though, notably, expresses caution in terms of appetite for mortgage growth (indeed, we saw further upward rate movements applied on Friday last). Stepping back, one suspects that significant further restructuring announcements lie ahead in the coming quarter(s).
Hammerson’s down after saying it’s “considering” a rights issue and is in advanced talks to flog one of its two outlets businesses to joint venture partner APG, the company’s 19.3 per cent shareholder. The confirmation follows Sky’s Kleinman reporting a raise in the works of around £600m, which’d be disappointingly small given the scale of Hammerson’s problems, but is possibly the ceiling given its £480m-ish market cap.
The outlets bit to be sold -- which is more mainstream than the other outlets bit and is a 50 per cent JV -- had a £693m value on Hammerson’s books at the end of 2019. Interims on Thursday would be a convenient moment to deliver both the sale and the rights issue. Here’s Kempen & Co:
We, along with a number of others, have long such suggested that a rights issues was becoming more inevitable as Hammerson’s leverage continued to rise and the disposal market dried up. However, we had factored in a c.£900m rights issue this year, followed by a £1bn of disposals in the proceeding couple of years, on the assumption that some liquidity came back to the market as values fell further. So at first glance, if true, £600m feels a bit on the low side, particularly because LTV was c.45% at 12/19A and probably closer to 47/48% as at 06/20A (perhaps more, given how harsh valuers appear to have gone in on other companies’ valuations). Therefore, without including any disposals, this alone would only bring proforma LTV only just below 45% - which would not be enough on its own.
The disposal of the 50% share in VIA does help LTV from a fully proportionally consolidated perspective nudging it closer to 40%, but remember this is the smaller of the two Premium Outlets businesses (£700m vs £2bn for Value Retail at 12/19A). APG is of course the natural buyer for the other 50% VIA and will be easier to sell at (or close to) book given the other party has a vested interest to keep values stable. . . .
These businesses have been the primary source of growth for Hammerson in recent years, and so for some, their disposal marks the selling of the crown jewels. But desperate times call for desperate measures, and with Hammerson not directly managing the assets, cash yields sub-3%, and serious questions over their near term performance given the slowdown in (particularly Asian) tourists, it would be no surprise if both were to go in due course. More importantly, this is likely one of the few areas in the portfolio with any investment market liquidity currently. We still expect disposals in Ireland, France and other smaller parts of the UK as Hammerson refocuses itself on being now the only listed UK prime shopping centre player.
There’s a warning of difficult trading from Senior, the Boeing-exposed aerospace and pipe engineer that’s based in Rickmansworth, Hertfordshire. One interesting thing about Rickmansworth is that it’s half an hour from Elstree Studios, so turns up in a lot in movies, usually pretending to be somewhere else. A local school’s in two of the Indiana Jones films pretending to be Connecticut. A farm just across the canal from Senior’s headquarters is a key location in 28 Weeks Later, Bohemian Rhapsody, Children of Men and Bridget Jones: The Edge of Reason. Anyway. Here’s Barclays to bring us back on subject with a summary:
First impressions – severe impact from Covid-19 and MAX production halt. Material decline in sales across both divisions, with lower cost absorption, and operational drop-through resulting in 580bps margin contraction to 2.2% at group level. H1 Cash is positive but weak, (£16m FCF), with higher restructuring costs expected in H2.
Sales: £409m, -31% organic (+2% vs BARC £401m), civil -42%, +5% defence
Adj EBIT: £9m (-45% vs BARC £17m)
Adj PBT: £3.6m (-68% vs BARC £11.4m)
Adj basic EPS: 0.7p (-68% vs BARC 2.2p)
DPS: no dividend
FCF: £16m (BARC £60m)
Net debt: £238m (vs BARC £86m)
Impairment charge taken of £110m on Aerostructures
Guidance – remains suspended
Operations – Restructuring costs of £35m in 2020, delivering annualised savings of ~£45m
BA now sees MAX production increasing to 31/mo by beginning of 2022, as compared to prior 31/mo ‘during’ 2021. BA will further reduce the 787 rate to 6/mo in 2021 vs 10/mo now and will reduce 777 to 2/mo in 2021 from prior 3/mo and push out 777X EIS until 2022 (~a year later). SNR shipset content - MAX (~$350k), 787 (~$450k), 777 (~$500k), 777x (~$750k). On MAX (SNR’s largest programme, ~20% sales pre-grounding), the supply chain is currently at different rates, and we see destocking ahead, with a slower ramp than BA, given 50% of content is supplied to Spirit direct, and excess inventory must be burned down first.
Investment View: Our stance on Senior is very much unchanged post the group's 1H20 Interims. We continue to assume a challenging near-term outlook for the group, especially in 2H20F, but we still believe in Senior's longer-term recovery potential and there are also additional growth and market share opportunities. In reality, we believe the share price is currently pricing in a lot of bad news (some that is not materialising, with the group's covenant update likely to reassure) and there is little benefit being given for any recovery potential. We reiterate our Buy rating, with 52% potential upside to our unchanged 80p price target.
1H20 Interims: 1H20 divisional sales are in line with guidance given in the recent pre-close statement (Aerospace -30%, Flexonics -27%, with group sales -30%; both divisions saw larger yoy declines in 2Q20 compared with 1Q20), as is the group's half-year net debt (£239m post-IFRS16, £155m pre-IFRS16). For completeness, 1H20 EBITA/PBT/EPS are better than JEFe, but are sharply down yoy, as expected (1H20 EBITA -81% yoy, with EBITA margins -580bps, to 2.2%) and the group incurred significant exceptional charges in 1H20 (predominantly due to a £110.5m impairment of the goodwill allocated to the Aerostructures business). Unsurprisingly, there is no 1H20 Interim dividend.
Outlook: Mgmt does not expect much of an improvement in trading in 2H20F, especially in the Aerospace division, and continues to focus on delivering cost-saving benefits (there are plenty more to come in 2H20F/FY21F) and cash generation. Mgmt has secured a Jun-21 covenant relaxation (having already negotiated relaxations for the Jun-20 and Dec-20 testing periods). There is, however, belief that the group's end markets will recover (Flexonics will be earlier than Aerospace) and that the group is well-positioned for that recovery, there are market share gain opportunities (the group's estimating/bid teams are currently very busy), and mgmt continues to focus on new technologies, new product development, and its ESG agenda, with good progress made on all during 1H20.
Forecasts: We update our model and make minor changes to our assumptions, but our FY20F-FY22F PBT/EPS are unchanged, which we think is a positive outcome. We recognise that consensus remains too high and needs to move to us, but this has long been the case, and we expect consensus to move lower in the coming weeks. We also keep our FY20F-FY22F net debt forecasts unchanged, which is another outcome we welcome.
Valuation: Based on our forecasts, the shares trade on a FY22F PER of 13.7x and EV/EBITA of 12.0x (for completeness, these are 87.0x and 27.7x, respectively, for FY21F) and the shares also offer a 6% and 5% FCF yield (FY21F and FY22F).
Still in aerospace, MTU Aero Engines of Germany has rather confusingly released Q2 updates both on Friday and this morning. The stock went up on Friday after full-year guidance came in above consensus. Today’s half-year results miss forecasts and the shares are down again. All in all it’s a weird way to run a listed company, albeit not the weirdest we’ve seen in Germany of late. Here’s Goldman Sachs:
Revenue held up better than expected in Q2 despite the temporary shutdown in defence, reflecting accelerated GTF warranty work. However, EBIT missed company compiled consensus by 12% (€6mn) due to a c.25% drop in spares revenues and the GTF warranty work dilution. FCF was particularly strong, partly due to a c.35% cut in capex in H1.
OEM: Revenues from commercial series (c.1/3 of commercial OEM) declined in high-single-digits reflecting lower delivery rates at Airbus and Boeing, while Spares declined in the mid-twenties, driving commercial revenues down 21% in $ terms. Revenues in military fell 15% reflecting disruption from the three-week facility shutdown. Margins fell in OE to 15.7% vs 24.5% last year, reflecting worse mix as high-margin Spares declined more than commercial series production.
MRO: Revenues were broadly flat in MRO (down 3% in $ terms), reflecting an increase in GTF warranty shop visits. However, as these revenues drop through at zero-margin, EBIT margins fell to 7.6% from 9.5% in 1H19.
FCF: MTU generated €125.2mn of FCF in 1H20, vs €235.4mn in 2019, 30% ahead of company-consensus for €96 mn of FCF. Of this, net capex on PPE was €63mn in 1H20, vs €99mn in 1H19. Liquidity was increased to c.€1.5bn via the extension of their RCF, and the placements of a promissory note and a Eurobond note.
Outlook: as announced on Friday, the company has issued new FY20 guidance consisting of: organic sales decline in commercial series OE of mid-to-high twenties, organic sales decline in spares of mid twenties, organic sales decline in MRO of low-to-mid single-digit, slight sales growth in military, adjusted group EBIT margin of 9-10%, adjusted net income growth in line with EBIT, and positive FCF.
And JP Morgan Cazenove:
At the mid-point the new sales guidance is 16% ahead of consensus but the new EBITA guidance is only 2% ahead of consensus; the guidance is also conditional on no new travel restrictions due to COVID-19. The better sales guidance is due to better than expected sales of new engines (partly due to B767 freighters and business jets), better than expected sales of spare parts (partly due to freight) and better sales of MRO (MTU using the free capacity in its facilities to fix engines under warranty for close to no EBITA margin). We struggle to see the shares going up from here given: (1) MTU’s guidance on EBITA was broadly in line with consensus; (2) COVID-19 data in Europe and the US has deteriorated; (3) the global air traffic recovery is faltering (per IATA’s downgrade last week); (4) the $/€ is moving the wrong way
Purplebricks, the Uber for estate agents, has results that are okay and guidance that’s moderately positive. Here’s Citigroup:
Citi’s Take — All things considered, we think Purplebricks has reported a solid set of results for FY20, although we think investors will likely focus on the outlook. That said, it is worth highlighting that for the first 10 months, UK revenues were flat despite a tough market even pre COVID (largely Brexit related). And market share is now >5% of completions. Of course, the next few months will be challenging with much uncertainty around the shape of the recovery of the housing market. But we continue to believe that Purplebricks is well placed to continue to drive market share gains, with a scalable model and high variable cost base, an enhanced balance sheet position and a focused UK-centric strategy. We rate Purplebricks Buy/High Risk.
Results vs. Expectations — Group results include the recently divested Canadian business. At a group level, the company delivered revenues of £111m (inline with recent Alpha Sense consensus updates), with gross profit of £68m (margins down 10bps YoY), with EBITDA of £1.8m. Net cash stood at £31m (although post the Canadian sale it is now £66m).
Focus #1: UK Trends — UK revenues of £80.5m were down 11% YoY, although they were running at flat YoY up to the end of February, before falling in March/April. Within that, instructions were down 23%, but offset by ARPI +12%, itself driven by underlying price increases, but also a ramp up in ancillary revenues. This is encouraging and likely a more sustainable way of driving further ARPI increases. Profitability was impacted by lower revenues/higher operating costs (largely investment in digital) although marketing was down 23% YoY. Share of listings stood at 3.9%, while share of completions, arguably the most important KPI, stood at 5.1%. Again, this is encouraging given the tough market backdrop.
Focus #2: Outlook — The outlook commentary on the UK market is cautious. The company expects listings to be down YoY vs FY20. The question is whether this can be offset by increases in ARPI – and at this stage we think it is difficult to quantify. That said, if Purplebricks can continue to take market share, and with a new pricing strategy set to be piloted towards the end of the summer (delayed from earlier in the year), revenues, and indeed profits, should be underpinned.
Focus #3: Cash Position — Post the sale of the Canadian business, Purplebricks is now sitting on a tidy cash pile of £66m. We expect some questions about its investment priorities, but with a focus on the UK market now we expect ongoing organic investment into building out its capabilities (the company calls out digital and its app, for example), we think this should also be supportive of market share gains and profitability.
Implications — Consensus for FY21 is relatively outdated, and with a wide range. The mid point of company compiled consensus points to EBITDA of £3.2m for the UK (vs £4.8m in FY20), and we think this will remain largely unchanged.
Anthony Codling, CEO of Twindig, was an aggressive seller of Purplebricks when he worked as a Jefferies analyst. His central criticism was that Purplebricks wasn’t very good at selling houses, which it covered up with partial reporting. Even after leaving the sellside he remains on the case, emailing:
“Is ‘pay now perhaps sell later’ coming to an end? Purplebricks is going to trial splitting the fee between listing and completion. Paying whether or not you sell was always going to be a hard sell in a tough market: Purplebricks instructions fell 23% in the year to 30 April 2020 that's a very significant fall when the majority of that year was not impacted by COVID
Over in the Stoxx Europe 600, Elekta of Sweden’s leading the way after Siemens Healthineers agreed to buy sector peer Varian, the big dog in radiation therapy. SH agreed an all-cash deal for Varian at $177.50 a share, or circa $16.4bn, implying 5.1x EV/sales and 29.6x EV/EBITDA. Here’s Goldman:
Varian is the market leader in the global radiation oncology market, with c.60% market share, with Elekta the other sizeable player, at c.40% market share. In FY19, Varian generated revenues of €2.8bn (vs. SHLG of €14.5bn) and adj. profit of €460mn (vs. SHLG at €2.5bn).
Over the past 10 years, the radiation oncology market has grown at c.4% pa, though growth in recent years has trended in the 5-7% range, largely driven, in our view, by a re-accelerated replacement cycle, in particular in the US and Europe. We note that Varian expect the global radiation oncology market to grow at 6%-10% pa over the mid-term, while Elekta had previously stated they expect the market to grow 6-8% growth pa over that time frame. We expect the global radiation oncology market to grow c.3-5% pa on average over the mid-to-long-term, though we expect growth in the short-term to be negative given headwinds to hospital capex from covid-19,
And Morgan Stanley:
Short-term: on the balance of probabilities, larger mergers rarely go smoothly, often dogged by integration complexities such as cultural differences, driving cost synergies and keeping the sales momentum going of the target. With deal closure expected in 1H 2021, we see it as reasonable that Varian employees may be subject to some uncertainty for 18-24 months. We suspect that may give Elekta an opportunity to take advantage of this situation and take some market share, or even some employees to strengthen its organization.
Long-term: evaluating what the long-term implications are for EKT is challenging. The Bear Case is that the combination of SHL and Varian creates a powerhouse in big data and artificial intelligence, resulting in superior software packages for the diagnosis and planning of cancer patients, which a smaller organization such as EKT is unable to match; furthermore having MRI technology in house, could allow the SHL/Varian combination to make faster progress in MRI based linear accelerators. The Bull Case rests on SHL's track record in radiation therapy, where they used to be a strong #2, but over a period of +10 years, executed in less than ideal way, and eventually lost the battle against Varian and Elekta, resulting in the closure of the business, with only the service business remaining for the installed base of Siemens linacs.Valuation: the price paid for Varian is ~20x FY22 EV/EBITDA (Sep Y/E), while EKT is trading broadly at half the rate on our forecast.
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