A smiley face chocolate lollipop stands on display inside a branch of Hotel Chocolat Ltd., in London, U.K., on Wednesday, March 23, 2016. Hotel Chocolat announced plans to list shares on London's Alternative Investment Market as the U.K. luxury chocolate retailer seeks funds to accelerate its growth. Photographer: Chris Ratcliffe/Bloomberg
© Bloomberg

Buy: Hotel Chocolat (HOTC)

Hotel Chocolat is doing well to mitigate a punishing cost environment for retailers, while improvements in factory capacity should help drive future efficiencies this year and next, writes Harriet Russell.

It’s rare to read a set of retail results lately where sales, margins and profits are all on the rise. But that’s exactly what confectioner Hotel Chocolat has managed to achieve. Half-year revenue rose by a respectable 15 per cent to £71.7m which, thanks to an expansion in margins, translated into a similar growth rate at the bottom line. The group also finished the period in a net cash position, supported in part by strong cash generation, and announced a maiden half-year dividend worth 0.6p a share.

Christmas was a clear success for the group, with sales up 15 per cent over the 13 weeks ended December 31 2017. Over the first six months, the group opened 10 stores, taking its total to 100, and an encouraging initial performance has prompted bosses to accelerate plans for new openings this year. This sits alongside a thriving digital sales channel, which includes Hotel Chocolat’s own website and third-party wholesale agreements with Amazon and Ocado. These partnerships accounted for roughly half of the 13 per cent acceleration in digital revenues.

Analysts at Liberum expect pre-tax profit of £12.4m for the year ending July 2018, giving earnings per share of 8.7p, compared with £11.2m and 7.8p in full-year 2017.

The shares’ forward rating of 37 leaves little room for error, but this is a company proving itself capable of consistent growth.

Sell: AA (AA.)

Increased competition and a lack of interest from younger drivers is worrying for the breakdown and insurance company, writes Emma Powell.

AA has been backed into a corner, forced to disappoint shareholders in the short term in the hope of securing the long-term viability of its operations. That means pumping cash into the business in an attempt to reverse the continued decline in membership numbers, while making its insurance products more competitive in a crowded marketplace. To fund these aims, the annual dividend will be cut to 5p a share for its January 2018 year end, and to 2p a share in 2019, remaining at that level until profit and free cash flow enable a change in policy. That’s a heavy drop from the 9.3p paid for 2017.

Cash profits are expected to come in at between £335m and £345m this year, down from a consensus expectation of £387m. Profitability will take a £12m hit from the decline in personal membership and business customers, as well as increased insurance premium tax. However, an uplift in the motor insurance book is expected to offset about £9m of this.

Additional capital expenditure of £26m is planned in the hope of kickstarting growth. Attracting new members has not been too much of an issue – paid new membership has risen almost a quarter since the 2014 IPO – but keeping hold of them has proved more difficult. New chief executive Simon Breakwell is pinning his hopes on digital improvements. By improving the breakdown app — only used by 30 per cent of members at present — he hopes not only to reduce call centre costs, but attract a broader range of customers beyond its traditional over-50s base.

About £35m has been earmarked for improving its “Stay AA” customer retention system, including helping it get better at staying in touch with members ahead of their renewal date. It also plans to roll out its “Car Genie” telematics product, with a view to launching a “connected car” digital offering, the latter would allow members to monitor the health of their vehicle and gain access to faster and more competitive insurance quotes, with the AA gaining more customer data.

Management is also hoping that investing in insurer hosted pricing systems — where rates are held by the insurer as opposed to an intermediary-controlled software house — will enable the AA not only to give more competitive quotes, but start offering insurance to non-members. They’re used by just five of the 12 members of insurers on its in-house underwriting panel at present. The group also wants to do more business through this channel, rather than third-party brokers.

Hold: Glencore (GLEN)

There’s little sign of the drivers that made 2017 a record year disappearing any time soon. Industry-wide under-investment in copper, cobalt, zinc and lead supply look set to support prices in both Glencore’s industrial and marketing arms, writes Alex Newman.

Glencore’s unusual structure — a traditional mining business stapled to a commodities trading house — is often hailed as a natural hedge in a volatile industry. But in 2017, what was invariably good for one was good for the other. Within the industrial segment, higher prices for copper, cobalt and zinc resulted in a 38 per cent cash profit margin in the mining of metals and minerals, up from 33 per cent in 2016.

Meanwhile, a 3 per cent increase in the marketing division’s adjusted operating income was largely down to the trading of metals and minerals, and tightening conditions in the copper, cobalt and zinc markets. That more than offset the drop in agricultural products earnings, where margin pressure was compounded by the sale of a 50 per cent stake in the division.

All told, this produced a very strong set of results. Group level adjusted operating profit more than doubled to $8.6bn (£6.1bn), gearing fell sharply, and $2.9bn of planned dividends put Glencore’s yield in the same league as the large miners from which Glencore seeks to differentiate itself.

The group’s assets include $470m of DRC-originated deferred tax credits, which Glencore hopes can be claimed against profits at the recently restarted Katanga copper-cobalt complex. But parliamentary approval of a new mining code has thrown existing tax stability agreements into doubt. If the bill is given the presidential seal, Glencore could be forced to write off some or all the $633m of total unrecognised tax-effected losses – more than last year’s entire group impairment. Additional proposals to introduce a “super profits tax” and the identification of cobalt as a strategic mineral could place further strain on one of Glencore’s chief sources of political risk.

On average, analysts believe adjusted pre-tax profit and earnings per share can improve this financial year, to $8.7bn and 44.5 cents, respectively (from $7bn and 38.3 cents in 2017).

Chris Dillow: The US inflation surprise

Economists were surprised last week by higher-than-expected US inflation. From a longer-term perspective, however, the surprise is not that inflation has risen but that it was so low in the first place.

Since the mid-1990s, you could have forecast annual core US inflation to about a third of a percentage point, simply by looking at the unemployment rate. High unemployment led to low inflation and low unemployment to high; the main exception to this was higher-than-expected inflation in 2010-11, perhaps because the recession created a mismatch between the unemployed and the skills companies wanted.

Last year, though, this relationship wasn’t so useful. For example, in January 2017 the unemployment rate was 4.8 per cent. Last week’s numbers showed inflation to be 1.85 per cent. Yes, that was more than economists expected a few days ago. But in a longer-term context, the surprise is how low inflation is, not how high.

There are good reasons why inflation might be less sensitive to unemployment now than in the past. For example, a more atomised workforce is less able to parlay labour shortages into pay rises.

Even if the risks do materialise, however, inflation won’t rise very much. The current 4.1 per cent jobless rate points to an inflation rate of only 2.4 per cent next January. Although there’s a close link between unemployment and inflation, it’s not a sensitive one. The mere fact that inflation has been stable in the last 20 years while unemployment has varied a lot tells us that inflation doesn’t vary much with unemployment – or with anything else for that matter.

So, what’s the problem? Two things.

First, if the Fed is to keep inflation down, it must raise interest rates by more than the rise in inflation. The Taylor rule says that a percentage point higher inflation requires a 1.5 percentage point higher fed funds rate.

Secondly, there’s the issue of the stock market’s likely response to this prospect. For most of the last 20 years there’s been a close correlation between output growth and equity returns. This tells us that if the economy grows well – and it’s not so sensitive to monetary policy that rate rises in themselves will prevent this — then equities can withstand higher rates. It’s possible, however, that this relationship will break down.

If ultra-low rates have boosted share prices because investors have “reached for yield”, the withdrawal of those rates might have disproportionately adverse effects on the market. Even if this proves not to be the case traders might worry that it will be — or worry that others will worry. This raises the danger that the road to higher rates might well be a rocky one for shares.

But let’s be clear. Investors’ problem is not inflation or even interest rates. It Is uncertainty about the market’s possible reaction to these that should worry us.

Chris Dillow is an economics commentator for Investors Chronicle

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