Markets Now - Wednesday 29th July 2020
The rash of “coronavirus changes everything” articles has eased a bit of late, perhaps in response to things not really changing all that much. Most sectors -- airlines, retail, real estate, whatnot -- are either clinging on for 2022 or accelerating the stuff they were planning to do anyway.
One industry to find itself both clinging and accelerating is movies. Big studio releases now are trapped in purgatory awaiting a time when box office might plausibly justify their sunk costs. Premium video-on-demand plans have been pulled forward, meanwhile, because the movie shortage is depriving cinemas of bait for their bait-and-switch gambit of selling snacks and adverts for other movies.
Overnight, Universal Pictures and US cinema operator AMC said they had agreed to shorten the new movie exclusivity window. New releases will now get 17 days in theatres exclusively, or three weekends, from 75 days previously. After that the studio can make its titles premium VOD if it wishes, with AMC taking an undisclosed split of the income. (VOD and sell-through exclusivity remain unchanged at around 90 days.)
AMC believes this structure’s going to be a win for both sides, which might be true. Alternatively, maybe AMC has overestimated its customers’ big-screen loyalty now that everyone’s out of the habit. How much goodwill has been eroded by charging £4.90 for regular popcorn and starting the film three quarters of an hour after the time on the ticket? Is waiting up to 17 days really that big an opportunity cost when it means not seeing that bloody VUE ident again?
Cineworld, AMC’s main US competitor, is down 15 per cent at pixel. Here’s Jefferies:
AMC sees two benefits from this ‘new industry model’: 1) A financial benefit from PVOD (undisclosed); 2) Greater studio profitability which should lead to more films. The first three weekends after release currently capture 75%-80% of any movie’s cinema revenues. But consumer behaviour will be critical: Will the allure of the big screen, sound and seats retain that high initial attendance rather than waiting 17 days? We think other chains, such as Cineworld, will only consider such a deal if PVOD share economics are improved.
Last CINE update: Liquidity extended, covenants waived. CINE’s 28 May update showed that lenders will waive leverage covenants. CINE has also extended liquidity by $180m: $110m in the RCF, $45m through the CLBILS loan scheme in the UK and an application for $45m from the US Cares Act. In June, CINE announced a further $250m from a private placement. We estimate a c.$40m monthly cash burn for CINE standalone (with only 15% of rents paid), the extension/placement extends cash burn to c18 months (from March 2020).
Looking through. Major new film releases have been delayed, reflecting cinema attendance uncertainty in the USA: Disney’s Mulan and the Christopher Nolan movie Tenet have both been delayed indefinitely (were summer releases). Cineworld is aiming to open US cinemas on 21 August. Once cinemas are permitted to open, social distancing measures may be in place, which would limit revenue generation and add short-term staffing costs. However, compared to many leisure venues with greater densities, we think solutions are workable in cinemas, with spaced seating and revised viewing schedules.
Current estimates. In mid-March, we cut numbers to reflect a 10% admissions decline across all divisions. We have not included a specific view on COVID-19 in our formal forecasts beyond a 10% FY20E admissions decline, but our ‘two months shut’ scenario shows a 40% EBITDA downgrade for FY20E. Our current FY21E estimates effectively assume flat admissions versus FY19 (which were 14% below FY18 in the USA).
And here’s Morgan Stanley:
Overall we see this is a crystallisation of our bear case for Cineworld, and had framed (industry-wide) PVOD as a 10-30% EBITDA risk, though this would likely be higher on a lower (post Covid-19) revenue/profit base (we expect 2022 revenues/EBITDA 14%/26% below 2019). . . .
1/ Context: in April, Universal successfully proved the economics of PVOD (higher revenue in 3 weeks of PVOD vs predecessor film’s 5 months in cinema) and announced its intention to continue using it in future. In response, AMC and Cineworld refused to licence Universal movies that did not respect the theatrical window.
2/ Likely that other studios and exhibitors will have to follow, ending a decades old theatrical model. AMC is the largest US exhibitor, and it is hard to see this paradigm shift not being replicated by other studios and exhibitors such as Cineworld.
3/ This will drive cinema attendance lower, but degree of cannibalisation a key question. Around ~80% of a typical film’s box office is captured in the first 3 weeks, so the key variables are how well films perform in cinema once available at home, and how much the appeal of cinema is reduced knowing that they will be available within a few weeks. Survey work conducted by our US colleague Ben Swinburne outlined the potential for an ~8% drop in industry attendance.
4/ AMC to receive a cut of PVOD revenues but economics have not been disclosed. It is likely the cut is under half the ~50% AMC receives from showing movies in its cinemas (given PVOD platform will take ~20%). However, this is still a positive which, if replicated across other agreements, will help to offset some of the impact for exhibitors. It is however unclear to what extent this revenue share will be maintained as PVOD becomes increasingly established.
We rate Cineworld Underweight with a 60p price target. We have flagged how Covid-19 has accelerated structural risks to exhibitors (which now appear to be playing out), diminished the capex-driven bull case on a Regal turnaround, and created uncertainty on the shape of cinema attendance recovery. Along with the main exhibitors in the US, Cineworld has not resumed operations, and the timeline for re-opening remains at risk (currently scheduled for 21 August) given the spike in Covid-19 has resulted in many states returning to lockdown. Litigation over the termination of the Cineplex deal also creates an additional (unquantifiable) risk.
Turning to results, Taylor Wimpey’s getting hit on interim earnings that make it look a bit like a normal company rather than a cartel operator. The half-year margin drops to 12 per cent from 23 (!!!) per cent last year on costs that couldn’t be taken out quick enough, resulting in a £16.1m loss. Revenue, down 58 per cent to £755m, was also a miss versus consensus because June activity didn’t ramp up as quickly as expected. That’s reflected in the completions guidance, with work in progress undershooting all that Help To Buy-subsidised newbuild demand that’s sucking all life out of the secondary market. Here’s Goodbody:
Given the group had already updated for current trading until mid-June in its June 17th equity raise update, the key incremental news for us are: i) Completions in the first half were down -57%, broadly in-line with what we have heard from peers over a similar period; ii) There has been no material change in rhetoric from a pricing perspective, with the group noting that sales prices during the shutdown remain consistent with pre-lockdown levels. iii) From a liquidity perspective, with the £510m equity raise coming just 2 weeks before period-end, it is perhaps no surprise that net cash has come in at £497m. The group notes it continues to see “new opportunities” from a land perspective and its total pipeline now stands at over 80 sites representing almost 30,000 plots; iv) From an outlook perspective, management is guiding for volumes this year to be down c.40% and there will be a “knock on impact on 2021 delivery”, broadly in line with our expectations for FY20 volumes -39% and FY21 -19% below 19 levels; v) Lastly it is also noteworthy to see the company stating it expects to recommence an ordinary dividend in 2021 (i.e. FY20 final). Overall, current trading looks to be in-line with what we have heard from peers and it is positive to see management’s expectations to re-instate the dividend. However what will be the key for us over the coming months is WIP. Indeed with management guiding for completions to be just over 9k, yet the group is 97% contracted on an order book of just under 12k units, you can clearly see that demand (at least for now) is there but the WIP simply is not.
And JP Morgan Cazenove off the conference call:
[T]he exceptional items on both overheads and others (cleaning, PPE, cabin, parking, etc.) would be incurred in H2 but at a lower rate as productivity improves. For 2021, the group expects a substantial reduction in these exceptional cost items. The CEO also pointed out that an optimal figure of completions to be able to reach the group’s MT margin targets was 14.5- 15.0k (2019: 15.5k), which implies gross margins for next year are likely to be lower if completions fail to reach pre-COVID-19 level.
On an optimistic note, Taylor Wimpey said pricing trends continue to be supportive, with most of the announced price increase at the beginning of the year gaining traction and in addition, the group has pushed 1% price increase on July 1. For 2021, management expect flat / +1% HPI for the broader market, with potential downside risks from macroeconomic factors (unemployment and consumer confidence).
While the group has guided for 40% y/y reduction in completions for FY-2020E, the CEO noted on the call that for FY-2021E – a halfway recovery (100 in 2019 to 60 in 2020E to 80 in 2021E) is the bottom-end (cautious scenario) of the group’s budgeting plan at the moment. The FD noted that the Work-in-Progress was up c.£130m y/y, and would expect similar move up at the y/e position. On ordinary dividend for 2020, management noted that (7.5% of NAV or min £250m) is still a good starting point for discussion, but noted that it would be the board’s decision.
Smurfit Kappa hasn’t cancelled its dividend to fund M&A, which is a relief for shareholders and a disappointment for those of us who like writing about M&A. The box maker says it’s retaining the payout on “belief in the inherent strength of the SKG business, its balance sheet, free cashflow generation and long term prospects”. That accompanies very decent first-half results from Smurfit, summarised here by Kepler Cheuvreux:
SKG posted H1 sales and EBITDA of EUR4,203m and EUR735m (margin of 17.5%) compared with our forecast of EUR4,150m and EUR713m (a margin of 17.2%) There is no updated consensus but Bloomberg consensus for H1 sales and EBITDA were at EUR4,073m and EUR674m.
Box shipments were better than what we had expected in H1. In Europe, H1 shipments were flat, while we understand they were down by c. 2% in Americas in H1. Earnings were slightly weaker in Europe, but this was offset by stronger than expected earnings in Americas which we believe is explained by successful cost cutting. On a positive note, net cash flow was strong for H1 at EUR238m compared with EUR159m last year.
At this early stage, our impression of H1 results is on the positive side. With resilient volumes, healthy earnings margins, and attractive cash flows, SKG is in good shape.
As usual, there is no explicit outlook in the H1 results. However, after talking to the IR team, we understand that the company has experienced a slight increase in business activity in Europe in July.
Davy Stockbrokers is keen:
Smurfit Kappa Group’s better-than-expected interim results reflect a business that is more resilient than its valuation rating implies. Its focus on innovation and sustainability is driving market share gains, while ongoing investment is providing margin-enhancing levers. Cash continues to pour from the business, providing the company with a range of shareholder value-enhancing options. Most notable is the decision to pay a dividend, which says more about the outlook than any comment in the statement.
Next, Next. A trading update covering the three months to the end of July shows full price sales down 28 per cent year on year, which is much better than the ~56 per cent drop management guided for at the end of April. Online’s the main driver, with Q2 sales up 9 per cent as bad press about its despatch warehouse proved easier to fix than feared. Next (echoing peers) also says it’s getting fewer returns, presumably because quite a few people are no longer able to use their office postrooms. Here’s Morgan Stanley:
As a result of developments in FY Q2 the company has revised its three scenarios for the year. Its profit expectations for FY 2020/21 are now +£195m in the central scenario, +£330m in the upside scenario and +£15m in the downside scenario. That compares with £0, +£150m and -£150m previously. However most brokers were already assuming that the company would do much better than this previous guidance (according to Bloomberg consensus was already forecasting Pre Tax Profits in FY 2020/21 of £195m) so we think that any upgrades today are likely to be fairly modest.
Based on existing consensus forecasts and last night’s closing price Next is trading on 15.4x Cal 2021 earnings, 10.4x EBITDA. This compares with a UK General Retail sector average of 15.8x and 7.7x respectively.- In line with Next’s longstanding IR policy the company is not holding an analyst call today. It will however hold a (virtual) meeting when it reports its FY H1 earnings in September.
And Peel Hunt:
In keeping with some of the stronger trading updates, such as Primark, Next’s Q2 recovery has proved to be better than feared (by management and the market). Management’s latest central scenario now generates c£200m better profit and cash flow than the last one. Critically, Next’s stock position remains on track and warehouse capacity now matches demand and so the business can move towards peak with a level of operational confidence. There will be upgrades to FY21 consensus, less so for FY22. We see Next getting back to £600m+ of profitability, recommencing dividends and shareholder returns. Buy.
Barclays Q2 results are a miss at the headline and a jumble of charges below. The idea going into the figures were that investment bank strength would overshadow all the bad stuff, most notably Consumer, Cards & Payments. It didn’t. Goldman can summarise:
Barclays has just released 2Q20 results. Adjusted PBT came in at £359mn, 27% below company-compiled consensus of £491mn, with better revenues and costs more than offset by higher impairments and lower other net income. Excluding the £100m negative impact on Visa shares, PBT would have come in broadly in line with consensus.
There are two main items standing out: Firstly, the performance of the IB was again strong in 2Q, with a 31% beat in PBT driven by stronger revenues. Excluding the gain on tradeweb in 2Q19, Barclays FICC revenues were up 88% yoy (in USD) and equities were up 27% yoy. This is comparable to US peers at +108% and 27% respectively. Banking fees were up 2% yoy, below the level printed by US peers (+48% yoy).
Secondly, impairments are a c.£200m miss, with the group adding another £1bn of covid-19/macro scenario provisions in the quarter. Guidance is for 2H20 risk costs to be lower (vs. 1H20), which seems to be already reflected in consensus expectations (£2.3bn for 2H20 vs. £3.7bn booked in 1H20).
In terms of divisional performance, we highlight: (1) the miss in Barclays UK PBT is driven by higher risk costs (broadly in line in terms of PPP), (2) the miss in CC&P is driven by lower revenues (also impacted by £100m negative valuation impact of Visa shares) - the group expects a gradual improvement in both Barc UK and CC&P income in 2H20 and (3) head office miss appears to be driven by an adverse valuation impact.
Capital came in at 14.2%, up 110bp qoq (13.1% in 1Q20), with the group having pre-released the c.14% CET1 level earlier in the month. The CET1 ratio includes c.75bp of IFRS9 transitional relief. The group guides for CET1 headwinds from pro-cyclicality and lower transitional relief from here.
TNAV came in at 284p (flat qoq), putting the stock on 0.39x trailing P/TBV.
And Caz for the positive take:
Barclays 2Q20 Adjusted PBT of £0.6bn is 18% ahead of company consensus (adj. for -£111m of negative items, details below) with a strong performance in the CIB offset by Cards, which is weak but recovering into Q3. Impairments remain elevated at £1.6bn and 14% ahead of consensus largely from a further £1.0bn macro-overlay which improved coverage. Capital improved +110bps q/q to 14.2% CT1, ahead of JPMe 13.9% and pre-announced c14%, supported by a 2% decline in RWAs and IFRS transitional impact (0.35%). We believe that these results continue to highlight the benefits of diversification for the group, with the strong CT1 and improved coverage ratios likely to reassure against any capital concerns. We continue to see risk-reward as positive in the context of the shares trading at 0.4x P/TNAV with H2 impairments indicated to be lower than H1 and consensus underestimating capital generation despite a tough 2020 outlook. Barclays trades at 5.3x P/E ‘22e, 0.4x PTNAV for a RoTE of 7.1% ‘22e, we remain OW and reiterate Barclays as our top pick in the UK.
Over in sellside, Investec turns positive on HSBC:
With (perhaps understandable) reluctance, we upgrade to Buy (from Hold). In the context of current geopolitical turmoil, as well as our own long-standing scepticism over HSBC’s ability to (ever) deliver against management targets, we find it hard to generate too much enthusiasm for this call. However, with the shares trading on 0.6x 2020e tNAV, at a 22-year low, the fact that, despite everything, it still appears capable of (1) remaining profitable and (2) paying a “best-in-sector” dividend yield through 2020-22e “demands” an upgrade.
We never regarded the “Gulliver 2011” 12-15% ROE objective as credible, and it was “dead in the water” within months. The “Flint 2017” plan to get to >11% ROTE by 2020 was similarly unconvincing and quickly abandoned. The more recent “Quinn/Stevenson 2020” plan to deliver 10-12% ROTE by “end 2022” appeared optimistic at the time of its February 2020 launch, and became almost immediately redundant as the near-global “lockdown” took hold.
We continue to see consensus expectations as too high; our EPS forecasts are 6%/14%/16% below latest company-compiled consensus (released 27 July) through 2020/21/22e, but we believe the share price selloff has now run ahead of downgrades.
HSBC, in common with its UK bank peers, suffered the “mandated” cancellation of its 2019 final dividend and a “block” on dividends during calendar year 2020. However, with a Q1 2020 CET1 capital ratio of 14.6%, and given our expectation that HSBC will remain profitable in 2020e (and beyond), we still see ample capacity to declare a 2020e “final” dividend (in Feb 2021) of 21c; a prospective 2020e dividend yield of 4.7%, rising to 30c/35c (6.6%/7.8% yield) in 2021/22e.
HSBC faces multiple headwinds, with (in particular) lower-for-even-longer interest rates and an existential crisis in Hong Kong. In 2020e, we forecast a 10% YoY decline in revenues and a 235% increase in impairments, leading, we think, to a 51% decline in underlying PBT to $11.0bn.
After a 14% 3-week fall, HSBC trades on 0.6x 2020e tNAV for ROTEs of 2.8%/4.1%/6.2% through 2020/21/22e. We trim our target price to 395p (from 400p) but upgrade to Buy (from Hold)
Carnival PLC (the bit domiciled in Southampton rather than in Panama) goes up to “hold” at Berenberg:
• Our view in a nutshell: We update our numbers for Carnival following the release of its full Q220 numbers, although we see little reason for increased optimism and leave our Sell recommendation and $10 price target. However, given the arbitrage we keep our £8 price target for Carnival plc unchanged, but lift the recommendation to Hold. While we applaud the acceleration in the fleet adjustments, we disagree with management's assertion that the business is highly cash-generative, and still believe that Carnival will struggle to generate cash given the debt it has accrued and the need for sustained investment in the fleet.
• Carnival has struggled to keep efficiencies: Carnival has spoken about the material efficiencies it is expecting to deliver following the COVID-19 pandemic. However, despite a focus on costs being apparent over the past decade, neither Carnival nor the industry has shown a great ability to keep the efficiencies at the bottom line. With revenues dictated by consumer confidence and a desire to sail at full capacity, we question whether the fundamentals will change moving forward.
• Reshaping the fleet is positive: Carnival has taken the decision to reshape the fleet, removing 13 ships over the coming months, and we applaud this move. This is expected to result in capacity not returning to 2020 levels until 2022 as ships on order launch. The launch of new ships is around five months behind schedule, with just five new ships expected to enter service before the end of 2021, which is less than we outlined in our 18 June note, Heading for the doldrums.
• Maintenance capex is meaningful: While Carnival is reshaping its fleet on the one hand, on the other it will take possession of 16 new ships between now and 2025, at a cost of c$14bn. Separately, capex outside of new ships will need to continue. This has averaged c$15 per available lower berth day (ALBD) since 2003 (and at a similar rate since 2012), and while this can be moderated in 2020 and 2021, we expect it will return to this level from 2022, which equates to c$1.4bn per annum. In combination, this means that Carnival will have maintenance capex of c$4bn per annum.
• Cash flow is not strong: Carnival claims that "the business has tremendous cash flow generation". While this may be the case in operational cash flow once capex and a much higher interest cost are factored into the equation, we remain of the view that it will be anaemic.
• Valuation: Given the material uncertainty, the anaemic cash flow and the significant leverage, we find the valuation is unattractive, although we do lift Carnival plc to Hold given the material mismatch with the Carnival Corporation share price. Our price target is based on a mix of our DCF as well as P/E and EV/EBITDA multiples.
Unilever gets an upgrade from SocGen, which retreads its theory from last month about a Reckitt merger:
We believe the surprisingly positive performance in 2Q20 should reassure those investors seeking to move into a defensive and recently underperforming name. The headline numbers ticked every box and the stock recovered what it had lost the prior month. But headlines on 12 weeks of operations are precarious. We dissect the reasons for the 17% EPS beat in 1H20. While UNA’s growing structural issues have not been resolved, we think it is aware of the need for a major strategic move and expect an accelerated transformation over the next 18 months. This spells a potentially compelling story that we believe could be greeted enthusiastically by the market. We lift our target price by 60% and our 20 EPS estimate 3%. We upgrade to Buy from Sell given the 24% expected 12m TSR.
A surprisingly good quarter provided an opportunity to abandon the margin target UNA’s almost flat underlying sales growth in 2Q20 was a positive outcome compared to our and the Visa Alpha consensus expectation of a 4-5% sales contraction. Better exposure to hygiene related products and a less net adverse performance in Foods from lost out-of-home sales, thanks to an increase in home consumption, accounted for the difference. Combined with a margin increase yoy of 50bp in 1H20, Unilever was at last in a good position to formally and firmly walk away from its ‘20% operating margin’ target.
Catalysts now turn more positive & “big picture” With the market less concerned about COVID-related sales risks, and the margin reset overhang dealt with, attention has now turned to strategic optionality in 2021. In our prior note, The Elephants start to dance, 23/6/20) , we outlined in detail the potential actions that are the more accessible to Unilever post a successful unification of its shares. We concluded that a merger with RB was the most compelling outcome in early 2021. We attribute over €25-30bn of value creation from this improved portfolio management strategy in the coming year (€14 of value/share).
Valuation and investment case While the strategic long-term value improvement accounts for the bulk of our TP increase, we also lower our WACC to 6% (from 7.2%) to reflect a lower 10y treasury yield and equity risk premium – this accounts for the majority of the remaining €10 of our target price increase. Although Unilever’s structural issues (that prompted our Sell for the last 18 months) have not disappeared, we expect it to address them via transformational actions over the coming 12 months. We expect the stock to outperform as anticipation of change grows.
Did you miss SocGen’s Unilever buying Reckitt fantasy M&A thing last month? Here’s some of the recap.
Unilever “needs to reinvent itself” and “needs to look more like P&G” by adding “later income cycle adopted products.” Buying Reckitt’s portfolios of OTC medicine, infant formula, condoms and hair removal cream, dishwasher powder, stain removal “could add up to €10bn of sales that we would classify as ‘higher income adopted’ categories,” SocGen says. “That would take Unilever to over 25 per cent of sales in lower household penetration/ ‘future proofed’ growth categories we think.” It continues:
We estimated that the sales & cost synergies from integrating the two operations would create value of over €29bn. Under this merger scenario, we estimate that the new entity would be c.70% owned by Unilever’s current shareholders, with RB shareholders owning the balance. Over 70% of RB shareholders currently also hold Unilever shares, we estimate. This would make swapping RB equity for a stake in a new enlarged merged business relatively straightforward, assuming the entire Unilever equity structure is first listed on the London Stock Exchange, as proposed in the latest unification structure.
If a merged UNA/RB entity were created, we suggested there would then be future optionality to carve out the food operations into a separate (Dutch listed) entity and to increase acquisitions in ‘late-income-cycle adopted’ HPC categories (including consumer health care). These actions would also be likely to be perceived as providing further opportunities to create value at Unilever in the medium term.
And Investec’s gone cautious on Aggreko ahead of interims due August 6:
There is continued uncertainty due to the Covid-19 crisis, particularly in relation to the Olympics in Japan; continued challenges in Oil & Gas and petrochem/refining etc; and FX risk in emerging markets. The company also lacks exposure to the accelerating green agenda. We have cut our target price to 440p, which now includes an earnings component, and our recommendation to Hold.
Olympics in Japan: Press reports suggest a downscaled event in a post Covid-19 world. Tokyo 2020’s CEO has stated the event “will not be done with grand splendour” with efforts made to simplify and reduce costs. This implies that less backup power is likely to be required. Further, the smaller scale of the event is likely to lead to a stronger environmental emphasis, particularly around the hydrogen economy, something to which Aggreko currently has no exposure. We have therefore halved earnings from the event, leading to EPS downgrades of 2% to 34.7p in FY20E and 10% to 36.2p in FY21E.
Longer term: In an economic downturn, the need for energy declines which is negative for Aggreko as an energy provider. Also, in the wake of the Covid crisis, the green agenda is accelerating up the priority list in many nations. Whilst it has some capability in this area, Aggreko is predominantly a gas/diesel genset based business. We have already adjusted our forecasts for downturns in various sub-sectors through to FY21E, thereafter reflecting some recovery so we leave numbers unchanged (other than for the Olympics). However, we believe there is a possibility that Aggreko could struggle to deliver underlying growth for some time unless it evolves its business model more rapidly for a changing energy world. We therefore prudently apply a P/E contribution (50%) to our valuation and use a 10x multiple, which we see as appropriate for a company with uncertain growth prospects and a suspended dividend.
View: Whilst we previously saw upside value and lower risk given Aggreko’s balance sheet strength, we believe uncertainty around the Olympics, working capital, EM exposure and a challenging economic backdrop warrant a more cautious approach ahead of next week’s interims which could flag challenges. Results are also typically H2 weighted. With mixed growth prospects and no dividend, we believe the equity value is unclear at the current time.
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