Markets Now - Thursday 27th August
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Say hello to Matthew Moulding. He’s the one in the middle.
The habitually shirtless Mr Moulding runs The Hut. It’s a Manchester-based brand incubator and ecommerce outsourcer and web host and warehouse developer and soap maker and owner of some hotels and some beauty salons and a photography studio and a second-hand classified listings site and an online translation service and is also a retailer of protein shakes, skincare stuff, grooming products, mainstream fashion labels, DVDs, homewares, bike bits, etc.
The Hut is on its way to the London Stock Exchange with a slightly arbitrary headline valuation of £4.5bn. The valuation’s arbitrary because Mr Moulding is only floating ~20 per cent of the company to raise £920m. The Hut will therefore disappear into LSE’s Standard Listing netherworld alongside the likes of Bigdish, Cleeve Capital, Senterra Energy and Argo Blockchain.
Raising less than a yard still requires seven bookrunners plus Rothschild, apparently, so expect quite a few buy ratings once the coverage blackout is lifted. In the meantime, all we plebs not on the marketing list have to go on is a website that talks of “high-end designer fashion brands, including Coggles, AllSole and MyBag” and a 2018 annual report logged with Companies House that appears to have been rendered on a Sinclair ZX Printer. There’s also an Intention to Float RNS that makes a number of fascinatingly granular claims, such as: “The directors of the Company (the "Directors") believe that [THG Beauty] was the world's largest online pure-play prestige beauty specialty retailer in 2019, based on revenue.” All the splits between product lines, categories and territories have been sketched with a very broad brush, eg:
Scoreboards, then, and we’re down because of reasons.
Rolls-Royce is unhappy after ugly first-half results from the overcomplicated jet-engine maker. Most of the headline numbers match an early July profit warning though revenue’s still a bit light versus consensus thanks to the roulette wheel of contract accounting adjustments. What’s going on below the headlines is incomprehensible and the CFO Stephen Daintith has quit, understandably. He’s going to Ocado, to concentrate on much smaller numbers.
Rolls has a new target to raise £2bn plus from disposals by the end of 2021 and new guidance for full-year revenue to be down between 25 and 30 per cent, so £11.2bn at the mid point versus a £12bn consensus. Management’s cash burn target for the year remains at £4bn but is based on a 55 per cent reduction in flying hours, which suggests a big fourth quarter recovery. Attempts to be reassuring about liquidity come with a caution that the company is “committed to our ambition of an investment grade credit profile in the medium-term”, so continues to “review a range of funding options to further strengthen our balance sheet”.
Here’s Credit Suisse to call the open wrong:
The CFO has announced his resignation and “the Board has begun a process to identify and appoint a successor”. The group indicates that it investigates “potential new forms of industrial partnership in relation to the UltraFan programme”. We think this cryptic comment could be interpreted by the market as 1/ a recognition that there is no widebody programme on the horizon and 2/ that Rolls-Royce may open itself to cooperation with other aerospace engine companies (the most likely candidate being Pratt & Whitney, in our view).
Stock reaction likely to be positive: Numbers appear complicated to assess, but FCF and net debt seem broadly consistent with expectations. Guidance do not look different from the July trading update. The absence of a rights issue and the perspective of the funding needs being addressed by disposals (likely to be less dilutive than new shares) is likely to be received positively by the market. This does not alter the fundamental outlook of the group’s operations, which remain extremely challenged.
And here’s JP Morgan Cazenove uberbear David H Perry (underweight, target 90p) to call the open right:
We expect RR’s shares to fall sharply today. . . . We continue to believe it needs to fill a hole of c£8bn caused by COVID. On page 25 of today’s release RR provides a scenario analysis including a “Severe but plausible downside scenario”; it says that: “…the inherent uncertainty over the severity, extent and duration of the disruption caused by the COVID-19 pandemic… represent material uncertainties that may cast significant doubt on the Group’s ability to continue as a going concern.” We acknowledge this statement may have been influenced by lawyers and accountants but we believe investors should take it seriously. In our view only a very major capital raise would put RR on a sound footing.
And here’s Jefferies’ Sandy Morris (buy, 500p target) with a circumspect take it seems few want to hear:
Plain talking. At end 1H20, Rolls-Royce’s net debt was £1.7bn, excluding leases. Guidance is for a ~£1bn 2H20 FCF outflow, plus £0.4bn of restructuring spend. End FY20 net debt is guided at around £3.5bn (with no receivables factored). Under Rolls-Royce’s Base Case, it returns to FCF positive in 2H21, but we estimate end FY21 net debt could be £5.0bn. Nonetheless, £2bn of business disposal proceeds (primarily ITP), FY22/FY23 FCF of around £1.5bn (moderated to reflect the business disposals), plus a £2bn equity raise could see Rolls-Royce in a net cash position of around £0.5bn at end FY23. That, we believe, would see the credit rating return to investment grade. This is the foundation for our PT of 500p.
New order. Today, Rolls-Royce outlines a “severe but plausible downside scenario”. In short, a “second wave” of COVID results in further stringent lockdown restrictions. Large Engine Flying Hours (EFH) fall 64% in FY20 (Base Case -45%) and are around 64% of their FY19 level in FY21 (Base Case ~70%). OE large engine deliveries fall 48% in FY20, and by a further 47% in FY21, implying OE large engine deliveries of around 140-150. There are other variables, but we venture the total FY20/FY21 adverse cash impact versus the Base Case could be £1.5bn. We believe a £2bn equity raise would become more immediate as business disposals would be difficult in FY21 and FY22 and replacing the RCF that matures in FY21 could be challenging, in our view. In Table 3 of our 29 July 2020 note we derived a TERP of 193p for a £2bn equity raise at 125p/share with a share price of 250p.
1H20 results in brief. FCF was an outflow of £2.8bn versus the ~£3bn guided on 9 July 2020. Allow for a £2.2bn impact from the cessation of invoice factoring and lower EFH and OE engine deliveries, and working capital unfolded much as expected, in our view. The Civil Aerospace underlying EBIT loss rose from £21m to £1,826m, but excluding COVID-related one-time charges, the loss was £608m (JEFe loss £450m). Defence EBIT rose from £173m to £210m (JEFe £138m). Power Systems EBIT fell from £104m to £22m (JEFe £40m). ITP EBIT fell from £32m to £10m (JEFe £15m).
No dragons, just COVID. The "severe but plausible downside scenario" might be seized upon, but we view it as Rolls-Royce helpfully signalling the factors that result in the current share price. The wider implications are nasty, in our view. We see Rolls-Royce battling lower EFH, but making good progress on restructuring and cash conservation. A return to FCF positive in 2H21 would be satisfactory and keep Rolls-Royce's options open, in our view. The 1H20 results are inevitably complex, but we see no reason to be discouraged. Rolls-Royce will do whatever it takes to guard shareholder value, in our view.
WPP, the once interesting advertising agency, has decent second-quarter numbers and a restored 10p interim dividend that’s based on a quite optimistic outlook and another bunch of cost savings. There’s a capital markets day planned before the year end to sketch out strategic progress, long-term cost cutting and to emphasise how boring WPP is these days. Barclays can summarise the gist of the statement:
WPP Q2 organic was better than expected at -15% (consensus -19%, Barclays -22%), July was down 9% and company is saying Q2 should be the bottom and FY organic should be in line with expectations (-10.0% to -11.5% in press release, -11.1% on average; we have -10.0% and we would expect consensus to move to us). H1 profit were also ahead (EBITA of £382m and headline EPS of 15.4p vs. our £283m and 8.3p and company consensus of £274m).
Outlook is re-assuring both in terms of net sales (Q2 should be bottom unless second wave, July down 9%) and operating profit (cost savings coming at upper end of £700-800m guidance with 25% permanent savings and FY20 in line with consensus of 10.4-12.5%, we have 12.2%).
Finally, the press release has positive comments about the new strategy (Wunderman Thomson and VML Y&R fastest growing integrated agencies, leading net new business wins, centralised production with Hogarth delivering, 8 out of top 10 clients taking e-commerce services). We should learn more at an investor day planned before year-end.
All in all, these are very re-assuring results which arguably show short-term and medium-term progress. We are Overweight WPP with a 760p target.
As can Morgan Stanley:
EBITA beat, guidance edged up, an interim dividend and positive on cost savings
Beat: H1 net sales were down 9.5% (MSe 11.5%) organic at £4,668m (MSe £4,616m). H1 EBITA was £382m (MSe £234m) with a margin of 8.2% (MSe 5.1%). WPP had said that margins in Q2 were likely to be “disproportionately pinched”, so this was a better than expected performance on costs. Net EPS were 15.4p (MSe 5.3p; 2019 34.2p) and there is a 10p interim dividend (MSe zero).
Q2 net sales fell by 15.6% (MSe 18.7%): This is well ahead of initial assumptions back at Q1 in April when consensus had WPP Q2 net sales down c20-25%. In the context of the agency group, Omnicom was down 23% organic in Q2, Dentsu’s International Network was at -20%, Publicis at -13% and IPG at -9.9%). As a reminder, WPP Q1 net sales were down 3.3% organic.
WPP has achieved c£296m of its planned £700-800m cost savings in H1: WPP announced at the end of March that it would make costs savings of £700-800m effective in 2020 in response to the Covid-19 disruption. It now says that 25% of this cost reduction (£200m) will be permanent.
WPP happy with consensus FY forecasts: This is more guidance than we expected. WPP defines consensus forecasts as:(i) Like-for-like growth in revenue less pass-through costs of -10.0% to -11.5% – we have organic net sales growth of -10.9%. We note that back in June WPP was happy with -11% to -12% so there is some improvement in the outlook there.(ii) and headline operating margin of 10.4% to 12.5% – we have a margin of 10.4%Our FY PBIT pre associates is £1,014m. We think that css PBIT numbers will likely edge up on a combination of solid revenue delivery and stronger than expected margins. CEO Mark Read comments “After two months in which our strategic progress could be measured by growth outside Greater China, the second quarter saw an inevitable downturn, with like-for-like revenue less pass-through costs declining by 15%, albeit better than our expectations. Assuming there is no second wave nor major lockdowns, the second quarter is expected to be the toughest period of the year, although we remain cautious on the speed of recovery.”
Quarterly progression – July at -9.2% organic net sales growth: After Q1 net sales growth at -3.3% and Q2 at -15.6%, we have -13.8% in Q3 and -7.4% in Q4 to give -10.9% for the year. WPP says that July is down 9.2%, which put s it ahead of schedule against our Q3 forecast.
WPP says current trading is showing sequential improvement on Q2, but that the market remains volatile: July LFL revenue less pass-through costs -9.2%. US -6.1%, UK -10.5%, Germany -7.2%, Greater China -18.6%, India -15.5%. (Q2 group -15.1%: US -9.6%, UK -23.3%, Germany -11.6%, Greater China -3.1%, India -25.1%). In 2021 we have organic net sales growth of 5.4% and PBIT pre associates of £1,336m, 14% below the 2019 level.New business wins were at $4bn in H1 (Q1 was $1bn), including wins from Intel, HSBC and Unilever.
Over in non-results sellside there’s Shell, which gets an upgrade from Exane BNP Paribas in a thunderous note called “BIG OIL: Who to own as we head towards sunset”:
Confronted by the imperative of decarbonisation the advent of COVID-19 has served to further rock the foundations of an international industry that was already being forced to fundamentally reconsider its business model, all while political pressure is increasing . . . . Launching on the US supermajors, Chevron (=) and Exxon (-), we review the strategies, portfolios and carbon profiles of the five oil & gas supers and ask “who should investors walk with into the sunset?” An era of divergence, conflict and challenge beckons. We upgrade Shell to Outperform, our preferred Super-Major.
This time the paths followed will be different. Europe to IEC, US stays IOC.
In an industry under pressure this time approaches will be different. After decades of mimicking and aping the corporate strategies of the US and European Super Majors look set to materially diverge. While the US will focus on what it knows best and drive hydrocarbon consolidation – not least in the US onshore - the Europeans will play to their already greater competencies across the full energy value chain and more likely morph into tomorrow’s international energy titans. In a rapidly changing world, capital allocation and in time business mix are poised for an era of very meaningful change. With it comes scope for very different financial and value outcomes.
Chevron the best for ‘Black’ but the value is in Europe, and especially so at de-rated Shell.
Black or green? We boast no strong bias in our choice of long-term partners. But in a world where transition is structurally altering the shape of the demand cycle, allocation mind-set truly matters. Of the US supers, Chevron’s value bias resonates. We initiate with a Neutral stance. In contrast at Exxon we struggle to gain comfort with an approach to allocation that plays to an iteration of past industry cycles. We start at Underperform. It is in Europe that we find better value - marketing, trading and investment plans that are aligning to a decarbonising world are all positives. Total’s more advanced ‘Green’ platform build has to carry favour. Yet it is at Shell where, post it’s ‘annus horribilis’, our portfolio analysis shows the greatest potential for value upside both ‘Black’ and ‘Green’. Our preferred super-major with the most attractive risk-reward profile we upgrade to Outperform with a 1590p target price.
Copper miner Antofagasta goes down to “hold” at Investec:
ANTO delivered a good set of interim financial results recently, reporting a strengthened balance sheet and a higher-than-expected dividend. This, together with a resurgent copper price, sees the company trading around 7-year highs (in US$ terms) despite COVID-19 and despite this being a weaker year for copper production. With limited forecast total return now, particularly In light of strengthening Sterling, we reduce our recommendation to Hold.
Good recent interims. Antofagasta last week delivered a good set of interim results, overall in line with consensus but ahead on net debt and final dividend. EBITDA was US$1,013m, -22.4% YoY (consensus US$990m), for a 47% EBITDA margin (vs. 52% last year), with reported EPS of 13.7cps, -55% YoY. ANTO finished the period with net debt of US$320m (last reported US$563m, consensus $526m) and declared an interim dividend of 6.2cps (consensus 5.0cps), 35% of the underlying EPS of 17.8cps (consensus 15.4cps), in line with the dividend policy. 1H20 capex was $549m (consensus $577m) with FY20 guidance maintained at less than $1.3bn. Adjustments to our forecasts post the interims see FY20E EPS increased 15% to 34.6cps, albeit with the 3-year average EPS (FY20E-23E) reduced by 2%. Our TP rises 2% to 1118p.
Good price momentum. ANTO’s share price has performed remarkably well this year, despite the impact of COVID-19 on global GDP growth forecasts and the more direct impact on the company’s Chilean operations, which has seen ANTO reduce its FY20 copper guidance to the lower end of its original 725-755kt range. ANTO’s share price is up 16% YTD (US$ terms) and up over 100% from its COVID-19 related low in late March. Strong copper demand from China, allied with disrupted global supply stemming from national lockdowns, has seen the spot copper price rise to US$3.00/lb (US$6,607/t), up 7% YTD and up 43% from its March low.
But ahead of valuation. While the copper price momentum suggests that we may be obliged to upgrade our copper price forecasts at the end of this quarter (currently US$2.80/lb for 2H20E and US$2.93/lb for CY21E), it would require a substantial uplift in copper prices, and ANTO’s valuation, to support an ongoing Buy recommendation, particularly given the ongoing strength of Sterling. We downgrade to Hold accordingly
And Homeserve goes down to “equal weight” at Morgan Stanley as part of a business services sector review:
WACCs continue to evolve with yields, but the divergence between "the best" and "the rest" is wider than ever. A re-calibration of WACCs to align with our fundamental Best Business Model framework of the sector is warranted. We continue to favour higher quality businesses as our top picks.
A WACC divergence: Falling real yields have driven risk premia lower and WACCs to new lows. However, investors have not been equally generous in lowering WACCs for all stocks. For the top 5 ranked stocks (in our fundamental Best Business Models framework), the implied WACC has on average fallen by 220bps over the last 5 years - manifesting in all time high multiples. Conversely, for the more cyclical/value stocks, WACCs have increased by c.160bps. For example, the current Experian and Rentokil share prices imply a WACC of 5-6% vs. 9-10% for staffers and Babcock.
What are we changing: The debate in Business Services all too often starts with valuation, rather than the inherent quality of each stock's business model; a paradigm that the BBM framework seeks to upend. And, for as long as bond yields stay low or fall further, it is appropriate that we should adjust our WACCs accordingly and systematically - we do that today with an average 40bps WACC reduction across the sector.
Homeserve fully valued at lower WACC - move to Equal-weight: As part of the updates we reduce our WACC for Homeserve to 7% from 7.5%. Our new PT of 1,370p is broadly in line with the current share price. We continue to like the compounding nature of the stock but see limited potential for outperformance vs. the rest of the quality names in the sector. In addition, a debate could be emerging on its organic growth run rate. Move to Equal-weight. Rentokil and Teleperformance are our top picks within the high quality/growth group. We also move B&S Group to Underweight as the shares are up by a third in the last week and we have no upside to our new €6.6 PT. The marginally improved 2H outlook is now priced in, with the shares at peak valuation at >15x 1y fwd EPS, despite organic growth (pre-pandemic) at a run-rate below the IPO guidance
• Updates might follow, influenced or otherwise by requests and complaints in the comment box.
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