Bull markets are fun in a way that bear markets aren’t.
It’s a distinction easily visible in the media. The 1999 dot-comedy had Show Me The Money, a fizzy daytime TV game show about stock punting that was every bit as engaging as that description, whereas the GFC delivered brooding Masters of the Universe schtick with Million Dollar Traders. Crises tend to make celebrities out of deeply serious, academic types like Roubini and Taleb whereas up markets are largely the domain of chaotic amateurs like David Portnoy and The City Slickers.
Among market professionals it’s obligatory to celebrate academics and sneer at amateurs, because professional salaries rely on maintaining the illusion of expertise-correlated returns. The chaotic amateurs have a much better strategy, however, which is to ignore equities completely until the circumstances exist that betting on literally anything gives them a greater-than-evens chance of winning. Their road will run out eventually, of course, but then everyone’s does, and it’s only the amateurs who seem to enjoy the journey.
Bull markets are party markets. When the shoeshine boys have stock tips only a square would think it was time to sell. Here’s a tweet from Umar Kamani, the socialite, Instagram celebrity and CEO of online frock shop PrettyLittleThing.
You’ll probably remember that in May Boohoo agreed a deal with Mr Kamani to buy the 34 per cent of PrettyLittleThing it didn’t already own for up to £323.8m. You’ll also likely know that Mr Kamani’s dad is co-founder and joint CEO of Boohoo.
Perhaps it’s a healthy sign for the bull market that Mr Kumani seems to be having fun with his sort-of inheritance by punting on microcaps like Amigo and Avacta that he reads about on ramptastic bulletin boards. Even if it’s not, however, he’ll still be rolling up to the club in a Lamborghini Aventador while Taleb pootles about in his Mini so who’s the real smart guy here?
Scoreboards, then. It’s all quite late August ahead of the Fed’s Jackson Hole mini summit, with some support coming from Wall Street’s inexorable low-vol grind higher overnight.
Provident Financial, the extremely subprime lender, has interim results that print a big loss but come with signs of stabilisation. There’s also a huge buildup of seemingly surplus capital which has to go somewhere -- perhaps into loan losses or maybe to back shareholders who knows. The shares are up 18 per cent at pixel. Here’s RBC to summarise the moving parts:
PBT ahead of (thin) consensus. Adjusted PBT of -£32.6m was £4.5m ahead of Visible Alpha consensus, but £113.0m lower YoY as impairments growth and reduction in receivables have weighed on profitability. Within the divisions, Vanquis Bank reported a £6.3m PBT beat . . .
All furlough support to the government repaid, in light of better-than-expected financial and operational performance than originally anticipated by management, which we take as a signal of confidence in short/medium-term prospects.
Receivables down 15% YTD to £1.88bn and 3% below consensus, which is likely to weigh on H2 revenue forecasts.
Capital position continues to improve with £215m headroom at 30 June, an improvement from £190m at end April 2020, and despite the disruption brought by COVID-19 the group remains well capitalised. Liquidity headroom on facilities of £1.2bn, are in line with the last reported at end April 2020.
No interim dividend proposed, in line with our expectation.
Improving trading conditions, but no new 2020 guidance commentary suggests that activity levels have picked up since June (in line with peers), with the business now said to be trading in line with internal plans for 2020, but there is no new guidance for the market for this year given the continued uncertainty.
Outlook – medium-term objectives delayed but not cancelled, as the CEO has reiterated that ROE of 20-25% and sustainable receivables growth through the cycle are still targeted over the medium term.
RBC Fundamental View
PFG operates four well-established, industry-leading franchises in the non-standard consumer credit sector. While we appreciate the strength of its market positioning, over the short term we see the group as facing a high degree of uncertainty due to the COVID-19 crisis. Trading on a Price to tangible book value of 0.8x with a 2021E ROE of 13%, it currently screens an inexpensive, however given uncertainties we can envisage better entry points in the short and medium term, and retain our Sector Perform rating.
Adjusted loss of £33m better than management expectations: Provident has reported adjusted H1 20 loss before tax of -£32.6m (H1 19: £80.4m). While slightly lower than our estimates, it was better than management had anticipated at the start of lockdown and ahead of Bloomberg consensus. Largest division Vanquis Bank saw PBT 87% lower at £11.8m (H1 19: £90.5m) due to lower receivables (through lower activity and tighter underwriting) combined with higher impairments as Provident reflected the deteriorating economic environment in its macro assumptions. Moneybarn reported PBT 85% lower at £2.4m as higher impairments (macro assumptions and increased arrears) offset higher revenues. CCD reported a loss of £37.6m (H1 19 loss: £15.1m) as lockdown saw customers and receivables reduce sharply in Home Credit. There remains limited visibility over H2 and beyond and while management remain committed to the targets set out in 2019, the timeframes remain uncertain.
Capital (with CET1 at 35.4%) and liquidity strength continues to differentiate: Provident reported excess capital of £215m at 30 June, higher than the Q1 level of £190m due to lower receivables and a lower PRA capital requirement. Liquidity was £1.2bn with £1bn at Vanquis and group covenants were eased. Provident also reported the end of Voluntary Requirement (VREQ), terminating the abnormal dividend and capital restrictions in place since 2016 between Vanquis and the rest of the group.
Reducing EPS estimates and PT but maintain Overweight: The lower H1 receivables combined with the higher impairments means we reduce our FY20 estimates sharply. We also reduce FY21 and FY22 estimates by up to 9% to reflect the lower receivables. Despite these reductions and the lack of H2 visibility, we maintain our Overweight as we anticipate Provident to be able to take advantage of a growing customer pool as a result of its sector leading brands and its strong capital and liquidity.
Provident reported a 13.4% decline in the loan book to £1,878m which drove a 12.5% reduction in revenue to £411.4m. Costs were well controlled and fell by 7.6% to £203.7m, and we estimate that there will be a further £10m of cost saving within CCD in H2. The pre-provision operating profit fell 16.9% to £207.7m and the Cost:Income ratio increased to 49.5% from 46.9%. Given the nature of Provident's assets we believe IFRS9 has had a disproportionately large impact on the group and their impairment charge increased 44.8% to £240.3m. Consequently, Provident reported an underlying pre-tax loss of £32.6m, which was materially better than forecast. Provident is very well capitalised with the group CET1 ratio increasing 25.5% to 35.4% from 28.2% leaving the group with £215m of excess capital which is equal to 44% of the group's market capitalisation. The group also holds £1.2bn of excess liquidity and importantly, for the first time Vanquis paid an interim dividend to the group and it also provided intra-group funding for the first time as well. The group is financially robust and recovery has commenced. July was a record month for Moneybarn deals, Home Credit is collecting at over 90% of target and now only 2% of Vanquis customers are on a payment holiday. Provident's credit quality remains very tight but the falling supply of credit from mainstream lenders is sending increasingly high quality customers to the group. As recovery builds, these assets are expected to deliver exceptional risk adjusted returns. Provident is being valued at just 5.7x 2021 earnings and 3.6x 2022 earnings. We have reintroduced a dividend forecast for 2021 and the 2022 dividend yield is forecast to be 8.6%
The Vanquis ring-fence has been lifted by the PRA, such that Vanquis can pay dividends and make loans to other Group companies. We view this as a significant positive and the result should help to lower the cost of funding over time.
We believe the H1’20 results demonstrate a sound performance in a period of significant uncertainty. The short to medium-term outlook remains uncertain and not without challenges. However, at this stage of the cycle we believe the Group is well positioned strategically (target market), competitively and from a funding perspective. The valuation is attractive, in our view, at P/TNAV of 0.85x in CY20E falling to 0.78x in CY21E. PFG is not without risk, but on balance we believe it offers significant upside and these results could well mark the turning point.
Demand for used cars has rebounded strongly according to Moneybarn, and despite tighter underwriting July was a record month. Suggests that perhaps the share price of S&U shouldn’t be drifting as low as it has. For Provident itself, it’s a positive among a world of pain and the recovery could be slow and drawn out. Not one that I would want to get behind at this stage given the increased provisions for both impairments and macroeconomic pressures. Of course these provisions could unwind in future and boost a potential recovery, but it’s way too early to tell if Provident can survive intact.
All in all, we see the market respond favourably to this update – it could have been much worse and while impairments are very high, some of this will be seen as judicious prudence on the part of management – and, should reduce the need for substantive charges in the coming quarters. The revenues beat to us is more important than the higher impairments given £73m of the impairment charge relates to higher provisioning in respect of worse macro assumptions / weightings. Outlook commentary is somewhat encouraging too. The short-term could see PFG’s addressable market expand as customers fall into the non-standard credit net – while some competitors are in a weakened state.
Shell, a large oil company, gets a downgrade to “underweight” from Barclays as part of a 110 page note on the rise of the ESG investor and how it relates to the European integrated Oil and Refining Sector. There’s a chart:
There are also key takeaways:
2020 to be the most difficult year in a generation: We expect Integrated Oil returns to fall to just 1.2% in 2020, the lowest level we have on record, led by falling commodity prices, production cuts and, unlike previous downturns, extremely weak refining margins. As a result, we forecast sector net debt levels to be up 12% y/y, with gearing ratios back to levels last seen in the late 1990s.
Cash breakevens are trending towards $30/bl, before dividends: We forecast sector capex to fall by 28% in 2020, the biggest decline we have on record in a single year. Unfortunately, despite improvements in the cost base, this has not been enough to protect dividends, with most companies having already reset shareholder return structures. We calculate a cash breakeven oil price before dividends of $32/bl in 2020. This is down from levels nearer $60/bl five years earlier, but we see further declines in the breakevens as likely, particularly once refining margins improve.
Low-carbon investments are growing in importance: Our forecasts see capex growing by ~8% pa to 2023. Some of this reflects increasing investments in short-cycle oil projects but we also think a growing proportion will be dedicated to lower-carbon businesses, particularly in Europe. This includes investments in power & renewables but also capital set aside to decarbonise the traditional oil & gas facilities through a number of technologies including the use of biofuels, CCS and green hydrogen.
US Majors trade at a large premium to those in Europe: We find the US Majors are currently trading at a >50% premium to those listed in Europe on EV/DACF multiples. This is as large a disconnect as there has ever been between the two regions and compares with premiums averaging 20% over the last 10 years. We think the growth of ESG investing in Europe is a likely cause, but with this type of investing also gaining traction in the US, we think it is reasonable to expect the valuation gap to close over time.
There are also recommendations. Repsol and Equinor go up to “equal weight” because they’re at fair value. Total remains Barclays’ European top pick, versus Chevron and Conoco in the US, with BP the preferred UK stock. Here’s the working on Shell:
Shell’s industrial performance remains in the fourth quartile with the stock continuing to lag peers on both returns and growth into 2021. On ESG metrics, the company screens better, helped by its bias towards gas, but this is not enough to offset the impact of weaker corporate metrics which are driving the industrial ranking lower.
The company was one of the first to take action amid the weaker macro, choosing to cut the dividend by two-thirds. We continue to see that as having been the right decision for the long term, but it also raised a number of strategic questions that remain. Industrially, the strategy remains unchanged – and our own forecasts project a material uplift in FCF in 2022 and 2023 – to by far the highest level of the sector. Yet the capital allocation strategy and how this FCF may be used does need further explanation to us. In particular, Shell’s medium-term capex outlook remains a key uncertainty, as well as its willingness to do M&A, the speed of the transition to renewables and ultimately what the dividend profile will look like over time.
These are important questions that we believe the company can and will address, but until those firm answers are provided we believe they are likely to act as an overhang on the shares. The management team has a chance to present a renewed strategy update in February next year, however that is nearly six months away and in the interim the near-term earnings outlook appears challenged, particularly for the company’s LNG division, and in the absence of trading gains, is likely to conceal any of the underlying progress being made on costs.
On valuation, having underperformed the sector, the stock screens as being cheap on multiples but also expensive on dividend yield. It is the latter that bothers us most and although we see the company’s focus on building a simpler, more consumer-focused business as eventually enabling a return to dividend growth, we see others in the sector as being able to move more quickly. We downgrade the shares to Underweight with an unchanged price target.
WH Smith, a newsagent, is getting a push from Goldman Sachs:
We initiate on WH Smith shares with a Buy rating and a 12-month price target of 1,500p, implying c.50% upside from the current price. In Travel, we believe WH Smith presents an opportunity to buy into a differentiated offering levered to a long-term attractive secular growth opportunity at high return levels compared with peers. We expect Travel sales growth to outpace High Street sales growth, and anticipate a c.10pp top-line substitution over the next four years; hence we expect a shift away from a competitive high street towards a more captive customer in travel, driving long-term upside to already best-in-class profitability.
And Peel Hunt’s keen on UDG Healthcare (to which it’s house broker) based on M&A around its main peer:
This week Kohlberg & Co acquired a majority stake in the US pharma services company PCI Pharma Services for an amount “substantially above” the top end of the US$2.5-3bn target range, according to press reports, implying an EV/EBITDA of over 17.6x. This provides strong validation of our UDG valuation methodology, and highlights the attractiveness of UDG’s portfolio . . .
PCI is a privately-held company founded in 2012 and headquartered in Philadelphia, close to UDG’s main Sharp campus in Pennsylvania. It is widely regarded as a high-quality close peer for Sharp, providing pharmaceutical development, clinical trial manufacturing and other services, as well as primary and secondary packaging and commercial services to the global biopharma industry. . . .
This is #4 in the list of high-profile PE acquisitions of UDG peers since January 2019 – In January 2019 Publicis closed the sale of its pharma CSO business, a peer for Ashfield Commercial & Clinical. Acquisitions of Huntsworth and Cello Health, peers of Ashfield Communications & Advisory, were announced in March and July 2020 respectively. The PCI deal completes the set of recent PE acquisitions across UDG’s peer universe, highlighting the value in the group. . . .
Our 1,050p TP is based on a blended average of peer multiple-based and DCF valuation methodologies. Among these we include an industry peer EV/EBITDA-based SOTP. The SOTP included in our TP calculation assumes: 1) ongoing external growth investment benefit; and 2) a 30% premium to the peer-implied EV/EBITDA based on UDG’s historical premium to those peers. Marking the peer multiples to market, UDG’s implied valuation on this basis is above our 1,050p blended TP. Even after excluding any unannounced M&A contribution to future EBITDA and removing the 30% historic premium, the SOTP peer implied valuation is 930p, c30% above UDG’s current share price (based on a peer harmonic mean CY20 EV/EBITDA for Sharp of 17.4x, close to the PCI implied figure). UDG recently acquired a stake in in a sterile packaging and manufacturing services business for US$37.5m at an implied c15x EBITDA multiple, validated both in terms of strategic rationale and price by the PCI deal.
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