The worst kind of famous is Twitter famous: it’s like winning a shouting competition where the prize is more shouting. Sympathy then for the marketing department at Reckitt Benckiser, whose shares are down 2.3 per cent at pixel amid a somewhat mixed response to its new Dettol poster campaign:
In truth, Reckitt’s share price move is probably less to do with its zeitgeist wipeout and more because its newish CFO Jeff Carr hosted a Zoom call with sellside on Wednesday. There were attempts at optimism but the main upshot was that Reckitt’s in remission having been run far too hot by previous management. Investors should know that already, of course, but reality might have been overshadowed in recent weeks by our enthusiasm for bleach. Here’s RBC:
‘A couple of good quarters as a consequence of COVID doesn’t mean everything’s right’ was Jeff’s starting point. While the COVID crisis makes him feel that the goal of mid-single digit underlying revenue growth will be achievable more rapidly than he thought at the beginning of the year (Reckitt Benckiser estimates that it’s currently 3-4% if the COVID effect is backed out) he repeatedly referred to the need to invest more in areas like marketing, R&D, supply chain, IT and demand forecasting.
Considerable demand for Dettol and Lysol has not been met, although with more than 10 agreements signed with co-packers to produce more of these brands this is one reason for management’s optimism over the coming months. But he also stressed that Reckitt Benckiser will not be able to depend on supernormal growth in these brands indefinitely.
Hence Jeff seems entirely wedded to the idea that additional margin resulting from the operating leverage as a result of the COVID-19 sales uplift should be reinvested to push sales growth towards the mid-single digit goal. That’s why he thinks that those who argue that Reckitt Benckiser’s margin expectations for 2020 should have increased owing to operating leverage following 1H’s strong sales growth are missing the point.
We were impressed with what we heard, but believe that the share price already reflects it. For instance, we already forecast 4.6% organic revenue growth by 2022, yet our Adjusted Present Value derived price target of £64 suggests that there is little further upside unless Reckitt Benckiser can sustainably exceed it; hence our Underperform rating.
RB has significantly outperformed the market ytd (+22% vs FTSE100 -21%), as the portfolio finds itself in the right place at the right time. However, the sales unwind into 2H20-1H21 could be significant, which is a risk given a 2021e P/E ratio of almost 27x. That still assumes a portfolio that can exhibit c.4%+ OSG in the medium term and margin improvement from the rebased 2022 level, both of which look elusive to us. In our view, the stock is in a bubble as a result of its short-term ‘where else do I invest?’ support.
SocGen also revisits its idea about a “merger with Unilever (post-unification) and the ultimate creation of an ‘HPC only’ business, which would see Unilever Food operations and [Mead Johnson Nutrition] combined into a separate operation.” Reckitt management “accepts that MJN is a very different business regarding channels and R&D requirements, and therefore needs to be run on a standalone basis,” it says. However, “given current valuations, we think Unilever may be the better vehicle for applying that logic right now.”
Want a bit of “whither the office?” stuff? Morgan Stanley provides with a sector wrap that follows a survey at the back of last month. The new research turns cautious on British Land, Land Securities and Merlin Properties, with its main takeaway “the extent of capital value declines is unclear, but lack of growth will cap returns”. It also brings to the debate a very exciting looking bubble chart:
COVID-19 to redirect real estate capital flows.
Low interest rates will most likely continue to drive significant flows into this asset class, but what could change is these flows’ destination. Previously, other than retail, most sub-sectors were attracting abundant capital. COVID-19 may have a profound impact on the perceived long-term desirability or risk premium for offices driving disproportionate flows into smaller sub-sectors such as residential, logistics and healthcare, adding to further and sustained polarisation in performance.
Amplified by occupational demand trends.
Struggling retailers and potentially weaker office demand (near term owing to cyclical pressure, longer term driven by working-from-home trends giving confidence to corporates to rationalise office footprints) could drive this polarisation even further.
Sticking with our positioning, despite wide valuation dispersion and increasingly consensual nature.
Retail stocks are (optically) cheaper than ever, but a lack of clarity on future share counts makes them quasi-uninvestible until balance sheet concerns are resolved. Current office fundamentals are more resilient than what stocks are pricing, but the risk of a material capital value impact is significant; we fear office stocks could be value traps as the outlook remains uncertain over most time horizons, and therefore focus on those that have the balance sheet to cope with most scenarios while avoiding stocks with above-average leverage. We see further upside potential in German residential and logistics names, even if that upside potential is now more modest than before.
Key price target and rating changes.
We downgrade British Land, Landsec and Merlin to Equal-weight, and also resume coverage of Covivio at Equal-weight. We reduce price targets for nearly every office-focused stock we cover; we are consistently assuming 6-7% drops in office capital values by the end of 2021, but we think that if we are wrong this could be worse, and we reflect this uncertainty by applying a wider target discount to all office-exposed stocks we cover. In these uncertain times, we generally have more conviction in our ratings than in our point estimate price targets.
New NAV methodology: tread carefully. Several companies have adopted the new best practice recommendations early. For some, this is causing material swings in reported NAV; goodwill and intangibles are being removed, but companies can be more aggressive on transfer taxes and deferred tax. We argue this serves as a reminder that it is not the absolute level of NAV (or NTA) but, rather, the return on that reported NAV (or NTA) that drives share prices.
Last month’s Morgan Stanley survey “suggests sustained demand to work from home; if anything, the mix of demand (and supply) has shifted modestly to more days at home vs. previous surveys”. It seems we’re really not missing proper bants that much:
[Of] office workers working from home during Covid, 82% would like to do so more in the future (unchanged). However, the mix of demand has shifted slightly to more days at home: 36% would do this 1 to 2 days a week (last survey: 39%, first survey: 42%), 43% would do so 3-5 days a week (last survey: 40%, first survey: 39%).
Employer policy (vs. employee demand) also more generous? 64% of office workers (last survey: 60%) believe their employers will allow 1-2 days working from home (44%, last survey: 42%) or more (20%, was 18%) (10). Geographic differences remain minimal. . . . .
Willingness to share desks. Responses here remain inconclusive: 40% are comfortable with ‘hotdesking’ once Covid-related concerns have died down (last survey: 39%); 37% are uncomfortable (unchanged), with the remainder indifferent. UK workers remain most resistant
Wirecard, a German payments processing company, is up by as much as 15 per cent on Xetra, which extends its three-day advance to more than 100 per cent. The latest leg of Wirecard’s rerating comes after the Financial Times of London published a 5,000 word profile of the group. We’ve not read it yet but presumably it’s mostly positive.
Elsewhere in the press, Capita’s up around 8 per cent at pixel after the Daily Mail reported:
TV licence collector Capita is being circled by private equity barons, the Mail can reveal.
The troubled FTSE 250 outsourcer – whose share price has fallen more than 80 per cent this year – is in CVC Capital Partners’s cross hairs.
But CVC, one of Europe’s largest private equity businesses which has previously owned Formula One and Legoland operator Merlin Entertainments, could face competition from a rival predator.
The interest could spark a bidding war for one of Britain’s biggest employers.
Capita, in a Response to Press Speculation RNS, “confirms that it has not received an offer from CVC to acquire Capita.” Reuters had earlier reported, citing “a source with knowledge of the matter”, that CVC “has no plans to launch a takeover bid for British outsourcer Capita and is only looking at specific units that the company is hiving off.”
Capita has said is auctioning its education software business. The Mail report says CVC “will likely want to take over the whole business and sell off the education division itself to ensure it gets the best price”, which is the kind of theory that often pops up when “private equity barons” are invited to take part in a firesale. Running numbers is what PE does, after all.
There are good reasons it’s a firesale though. And with Capita down more than 80 per cent from its year-to-date high, a takeover at a normal sort of premium would be asking quite a few institutions (RWC, Schroders, Invesco, Ninety One, Jupiter, River & Mercantile, etc) to crystallise some very grim losses lurking in their funds. It’s no surprise therefore that PE has so far failed to make the numbers add up. Here’s Panmure Gordon:
We think there is some logic to the story, albeit there are good counterpoints too. Capita is a diverse collection of businesses and it has said that it is looking to sell some of them, especially in the Software and Specialist Services divisions and it may be that there could be interest in looking at the wider group. In particular, Capita is currently actively looking to sell its Education Software Solutions business and we wrote in our last note on Capita (from 18 August) that “the planned disposal of Education Software Solutions (ESS), announced in June, has now commenced and management said that there has been a good level of interest from buyers. Proceeds from ESS will be used to pay down debt and the pension deficit. Further disposals of standalone software businesses and businesses within the Specialist Services division are being pursued”.
The Daily Mail story mentions that CVC “could face competition from a rival predator” and that “the second suitor is understood to be interested in buying Capita’s education software division”. We also note that Capita’s valuation has de-rated significantly in recent years so that it is now trading on a FY21 PER of 3.7x which could prove attractive to potential private equity interest.
However, trading at the company has continued to be tough and we think many of Capita’s businesses face structural headwinds, and that any potential bidder for the whole group would find it difficult to turn some of these businesses around. Plus, Capita already has a degree of financial gearing with historic 1.9x Net debt/EBITDA and a reasonably high pension deficit, with a net liability of £87m at 30 June, so equivalent to 18% of the market cap of £490m, which may dissuade interest from private equity. Also, private equity interest in ESS does not necessarily mean that private equity could be interested in the whole company.
Recommendation; we have a Sell recommendation. The shares are not expensive on a 2021 PER of 3.7x and we think management are pursuing a sensible turnaround strategy of investing in the better businesses and trying to sell the weaker ones. However, we think it will be difficult to improve a diverse collection of businesses, many of which face structural headwinds especially in terms of competition and market position, and that selling the non-core businesses in the Specialist Services division, which are particularly challenged, will be tough.
Melrose Industries, the private equity barons whose equity isn’t private, is leading the FTSE 100 gainers after interims. Group sales were flat and ebita was up 8 per cent on a margin of 1.3 per cent, resulting in a 0.7p EPS loss, which looks slightly better than a very unreliable consensus. Net debt’s nearly £4bn which again is no worse than expected. Management talks of “some early signs of recovery in certain geographies, although GKN Aerospace will continue to experience market uncertainty,” adding: “We also expect that 2021, and beyond, are likely to bring acquisition opportunities.” Presumably that also means disposals.
Below the headlines there are lots and lots of moving parts so we’ll just cut to Barclays to give the overview.
We view this statement as positive. H1’20 performance was in line to slightly better vs. expectation with recent trading across Auto, Powder Met and Nortek seeing a noticeable improvement July/Aug vs. Q2. Margin targets have been upheld at Powder Met and Auto (14% and 10% respectively), while despite the challenging outlook Aerospace has only come back by 200bp to 10% (although this is based on only limited market recovery over the next few years). Restructuring as expected will accelerate in H2, helped by the additional headroom given by the covenant waiver, with it continuing into 2021. Savings are expected to be greater than £100m vs. previous guidance of c£100m. Outlook, while cautious, is highlighting signs of improvement, which underpins current consensus expectations in our view.
Consensus: FY20 consensus expectations are for EBITA of £240m and a margin of 2.7%. We see these as well underpinned.
Valuation: Melrose trades on a 2021 EV/EBITA of 15.2x vs. the sector on 19.1x.
Back to sellside, and Morgan Stanley’s gone negative on Next. As always with analyst Geoff Ruddell, it achieves the gold standard of equity research and gets straight to the point:
Next’s share price is higher today than it was a year ago. This makes very little sense to us. We downgrade to Underweight.
Next has been hit hard by the Pandemic... Even in its own ‘Upside Scenario’ Next’s revenues are likely to fall 18% this year and its profits more than halve. Although its debt will be down (mainly due to the shrinking of its loan book and a sale-and-leaseback of its freehold assets), its leverage will be up and it may need the covenant waiver it has agreed with its banks
.….but its shares haven’t. Next shares are slightly higher today than they were a year ago - when there was no pandemic, the economic outlook was broadly stable, and Next was on course to make £725m of profits and to return £500m of this to its shareholders. Even if we assume Next’s ‘Upside Scenario’ we calculate that the company’s ERR hurdle (ie the price above which it would deem its shares too expensive to buy back) is currently only c3300p.
We see excitement about Next’s online business as misplaced… On our new analysis 64% of Next’s UK online sales last year were made on its in-house credit, leaving it vulnerable as the credit cycle weakens. Credit penetration is even higher at Label (most of whose sales we see as substitutional, not incremental). Label is not positioned as a brand in its own right and we think its proposition appeals more to suppliers than to (non-credit) consumers.
...and believe the group’s EPS growth algorithm may now be broken. Thanks to a combination of EBIT margin expansion and share buy-backs, Next has averaged 10% annual EPS growth over the last 15 years, despite sales growing by just 2.5% CAGR. But with stores now under huge pressure, credit profits set to fall and changing business mix online, we see EBIT margins declining (COVID 19 disruption aside). And further share buy backs look unlikely to be possible for some years.
We see the shares as very over-valued so downgrade to Underweight.... In recent weeks Next has been trading on its biggest ever valuation premium to both Kingfisher and M&S. Although we keep our forecasts and our 3650p price target unchanged today, we downgrade our rating to Underweight.
…but expect near-term guidance upgrades. While we are bearish on its longer- term prospects, we see Next’s ‘Central Case Scenario’ for FY 2020/21 as too conservative. We think upgrades are priced in but, if we are wrong, or if the sector’s newsflow-driven momentum continues, the shares may run higher.
Over the coming year, will macro conditions remain supportive for utility valuations?
Yes. The Federal Funds Rate hovers close to zero; the ECB deposit rate remains negative; the European money supply (M3) has grown 10% in 2020 and 50% in the last 5 years. These conditions mean an unprecedented availability of low cost capital – for companies with the right activity set.
Q: Will flows into ESG funds continue to support stocks with exposure to green themes?
Yes. Despite policy challenges in the US, we expect flows into ESG funds to continue (having hit record levels in Q2 2020 already). Our analysis suggests the supply/demand balance for ESG-attractive investments will be supportive for the utility sector, perhaps for much of the 2020s.
Q: Will energy transition policies result in higher growth and capex for the sector?
Yes. We see six major policy catalysts in Europe that could accelerate value creation in the sector: (i) the Green Deal; (ii) the EU stimulus plan; (iii) the 2030 carbon target; (iv) ETS reform (carbon scheme); (v) the EU taxonomy; and (vi) a possible carbon border tax. All could be important in the next year
What’s priced in? We believe markets are pricing in higher EBITDA multiples for some, but not all names (Fig 26). In general, multiples for renewables & networks have risen from 8 -10x to 9-11x, and could go to 10-12x.
Upgrading EON and Engie, from Neutral to Buy
E.ON is the leading distribution network play in Europe, but has lagged peers this year and trades today at a similar level (c€10) as 18m ago – when BYs were 50 bps higher and peer valuations 20% lower. We upgrade to Buy with a new target multiple of 12x on the networks (PT €12, 20% upside). Engie has also lagged peers in 2020 but we upgrade now for different reasons: Covid risks are priced, while the benefits of the new disposal strategy (and some balance sheet positives) are not. Even with a low 9x and 10x on renewables & networks, we see FV at €15 (+30%). Buy, PT €15 (was: €10.75).
Downgrading Orsted and EDF, from Buy to Neutral
Orsted is the clear leader in offshore wind, and one of the least exposed names to the range of Covid related risks. Yet much is now priced in, including (on UBSe) 20+ GW of future growth. The opportunity to buy in at a discount earlier this year has passed and we return to Neutral (PT 900DKK). For EDF, we await a catalyst from the EU (approval of a new nuclear regime in France) which could be powerful indeed – but could also be delayed, or disappointing. We wonder if the real news (what power price nuclear can earn) may even be delayed beyond the 2022 election? Back to Neutral, PT €10
• Updates might follow, influenced or otherwise by requests and complaints in the comment box.
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