Buy: Aviva (AV.)

The renewed strength of its balance sheet means that the insurer is planning to utilise £2bn in surplus capital this year, writes Emma Powell.

Within its latest full-year figures, Aviva, floated the possibility that it could cancel £450m in high-yielding preference shares at par value through a reduction of capital — a prospect that has some institutional and minority shareholders up in arms.

It is apparent that some investors had considered the non-redeemable preference shares in question as permanent securities. However, Aviva told the IC that the issuer’s rights relating to cancellation were contained in the documentation originally sent to preference holders. The prospectus stated that the shares were not redeemable, but that is not the same thing as saying they cannot be cancelled.

Unsurprisingly, the Aviva announcement triggered a sell-off across the wider market, with prices for both Aviva’s 8.75 per cent and 8.375 per cent securities down by nearly 30 per cent. The news also prompted the Ecclesiastical Insurance Office to reassure investors that they have no plans to cancel their preference securities.

Aviva said that the possible cancellation is part of a process to balance the interests of ordinary and preferred shareholders, but there are fears that ordinary shareholders could be used to railroad any decision, particularly as it would save about £38m in coupon payments. However, there are holders of both preference and ordinary stock in Aviva, which could conceivably sway the issue (along with any bad publicity).

Buy: John Menzies (MNZS)

The shares trade at 11 times forecast earnings, representing a slight discount to the historic average relative to peers. However, the group’s new focus and strong performance indicate there is the potential for further growth, writes Tom Dines.

It’s a little over a year since John Menzies’ pivot towards aviation services, and the strategic shift already looks to have been vindicated, with 150 (net) contract wins through 2017. The aviation division, which includes check-in and cargo services, drove significant profit growth in the group at large, with adjusted pre-tax profit up 27 per cent at constant currencies, while free cash flow also strengthened, with the year-end balance of £49.2m representing a 58 per cent increase.

A key part of the shift was the February acquisition of ASIG, which was acquired to add plane refuelling to the business mix and open new markets. Integration has progressed smoothly and management is now guiding for cost synergies of £15m, from an initial estimate of £10.5m. The $202m deal caused net debt to spike, but it came down to 1.9 times adjusted cash profits by the year-end, inside the two times multiple targeted by the end of 2018.

The group is still looking to offload its distribution division, which has been struggling with the decline in print media in recent years. Earlier plans to spin out the division to combine with DX were scuppered, but John Menzies has appointed advisers and has begun a sale process.

Foreign exchange headwinds caused analysts at Peel Hunt to cut adjusted pre-tax profit expectations by 3 per cent. They are now forecasting £69.6m in 2018, giving earnings per share of 61.9p (from £67.1m and 57.2p in 2017).

Hold: Fever-Tree (FERV)

The drinks maker’s shares fell on results day, but the only cause for disappointment was the 170 basis point contraction in the gross margin, writes Julia Faurschou.

Fever-Tree is hoping to replicate its success at home on the other side of the Atlantic. The company is establishing its own north American operation with a dedicated management team to take advantage of a premium mixer market that management feels is still in its early stages. The US is already the company’s second-largest market, with sales up 39 per cent to £29.5m during 2017.

The UK market is not showing signs of slowing, either. Sales nearly doubled last year to £87.8m and Fever-Tree is now the number one mixer brand across UK stores. The growth in off-trade was aided by further distribution agreements with retailers and better product placement on shelves.

Analysts at Investec expect pre-tax profit of £59.4m during 2018, giving earnings per share of 41.1p, compared with £57.1m and 39.8p in 2017.

Fever-Tree’s margin pain could be exacerbated this year by expenses relating to the north American business. But operating cash flow as a proportion of adjusted cash profits improved from 71 per cent in 2016 to 74 per cent last year, and the company is in a net cash position, so it looks well placed to fund expansion plans without compromising the dividend. All that said, by trading at 62 times forward earnings, the shares hardly offer an appropriate entry point.

Chris Dillow: Retailers’ housing problem

Things are looking ugly for the UK’s retailers. Big names such as Maplin and Toys R Us are closing; Carpetright and Mothercare have issued profit warnings; the John Lewis Partnership has reported a big fall in profits; and others such as New Look are closing branches. Official figures next Thursday will highlight these troubles. They are expected to show that sales volumes have fallen in the past three months.

One big reason for these woes was highlighted last week, when the RICS reported that sales of houses are depressed and that estate agents have few properties on their books. Weak housing transactions are bad for retailers.

History tells us this. Since the mid-1990s, fluctuations in mortgage approvals have led with a lag of a few months to fluctuations in retail sales. Rising mortgage approvals in 2001, 2004, 2006, 2009 and 2013 all led to rises in retail sales a few months later, while falls in approvals in 1997, 2008 and 2012 led to falls in sales.

One reason is simply that moving house creates demand for things such as furniture and carpets. But there’s something else — a framing effect. If you’ve spent weeks thinking about an expenditure of hundreds of thousands of pounds your sense of the value of money becomes distorted. A few hundred pounds doesn’t seem as much as it otherwise would. So you spend more generally.

We should not therefore be surprised that retailers are suffering while the housing market is in the doldrums. While much has been made of high house prices, it has been insufficiently appreciated that volumes matter too. It might be that we have the very worst type of housing market. High rents are squeezing the real incomes of renters while also creating political discontent, while high prices and a lack of easy credit are depressing transactions — something that reduces consumer spending in itself.

In this context, perhaps economists (including myself) have been wrong. We have been critical of policies such as Help to Buy and stamp duty holidays for first-time buyers in the belief that they simply push up prices further and so benefit homeowners (and Persimmon bosses). But perhaps this misses the point that such policies help to stimulate housing transactions and therefore support the retail sector generally.

It’s in this context that we should perhaps welcome Theresa May’s proposals to encourage more housebuilding. These probably won’t do much to cut house prices — new builds are too small a proportion of the overall housing stock to do that. But in putting more properties on the market, they might stimulate turnover, which in turn would help retailers.

But how much help do they need? In this context, we’ve had some good news recently. Latest Bank of England figures show that mortgage approvals jumped to a (seasonally adjusted) six-month high in January. Granted, this is only one month’s number, and it is only just over half the number of approvals we saw at the peak of the market in 2006. But it might (only might) be a clue that things will get better for retailers in a few months’ time – if, that is, they survive that long.

Chris Dillow is an economics commentator for Investors Chronicle

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