It’s probably been a good morning for people who like to talk about international trade treaty protocols and the mechanics of options market gamma hedging. Neither story is visible on the mid-session scoreboards, however, where volumes are meagre due to the US Labor Day holiday and stocks are up for no particular reason:
We’ll start instead with The Hut Group. You remember Hut, right? It’s the soon-to-float affiliate-marketed multiline online retailer and seller of affiliate-marketed protein shakes and maker of affiliate-marketed cosmetics that also owns hotels and charters planes and hosts websites and builds warehouses and makes soap and does ad agency work and runs photo studios in London, Manchester, Leeds, Portugal, Utah, Warrington and Macclesfield. Saturday’s FT had an interesting profile, if you need a reminder.
There are a few things about Hut that seem a little unorthodox. Why, for instance, is Dominic Murphy classed as one of its two independent non-executive directors? Mr Murphy brokered KKR’s deal to buy 20 per cent of Hut in 2014 and holds a sizeable personal stake in the business, so it’s tricky to see him as completely independent of management. The same could be argued of the other two non-executives, Edward Koopman of Sofina and Iain McDonald of Belerion Capital, given their firms are both long-term investors. Both Mr Murphy (appointed 2014) and Mr McDonald (appointed 2010) have already overstayed their welcome according to the Financial Reporting Council, which doesn’t like non-execs lasting more than six years. Then there’s Zillah Byng-Thorne, the senior independent director, who was an advisor to the company for four years before joining its board in 2018. Not one bit of this seems in the spirit of the Combined Code.
Another question involves the group structure, the question being: wtf? Hut finance director John Gallemore has more than 80 companies listed against his name at Companies House in three separate listings. Directorships held by Matthew Moulding, Hut’s Chairman CEO and golden shareholder, also appear in three different places and there are quite a few apparent mistakes, such as in The Hut Management Company Limited, where Mr Gallemore is listed as both active and resigned. Companies House is often a bit of a mess so there’s every chance that Hut is blameless here. However, given Hut’s flotation plan involves Mr Moulding hiving out its property portfolio -- the offices and the warehouses as well as the hotels -- then renting them back to the company, it would be handy to have a clear view of who currently owns what.
Another question involves Mr Moulding himself. Quite a few photos disappeared recently from his Instagram account. Those no longer visible include the one we used a few weeks ago of Mr Moulding sharing a jeroboam of Dom Pérignon with some friends and/or non-executive directors. Also absent are several of Mr Moulding enjoying some mentoring from investor Sir Tom Hunter at Blue Marlin Ibiza, which means we only have low-res cached versions such as this:
If anyone’s able to reunite Mr Moulding with his holiday snaps please get in touch via the usual routes.
Over in movers, FirstGroup’s up more than 20 per cent at pixel after the Sunday Telegraph reported a “buyer scrum” for its US Student and Transit businesses, which the bus company put put up for sale in March. It also says Coast Capital Management, FirstGroup’s biggest shareholder, plans to vote against board re-election at this month’s AGM as a symbolic protest.
The Sunday Telegraph has learnt Canary Wharf owner Brookfield, Apollo Global Management and KKR are among a slew of potential suitors for FirstStudent and FirstTransit.
Sources said FirstGroup’s financial advisers had restarted a sales process in recent weeks and attracted significant private equity interest.
I Squared Capital, the owner of Energia, one of Ireland’s two main energy firms, is also understood to have registered interest
The SunTel cites analysts as valuing the two US businesses back in March at $4bn (£3bn) versus a live market cap on FirstGroup of £600m. RBC says it was on £2bn or 5x EV/ 2021E EBITDA, which is at the bottom of the historical M&A range of 5-8x EV/EBITDA. The capital structure confuses the picture quite a lot though, as FirstGroup has £1.3bn of net debt and £2.4bn or thereabouts of capitalised leases mostly tied to its UK rail division. Here’s a SOTP from Cazenove:
Future’s up on another brief and shorts-defying trading update. Full-year results to end September from the magazine publisher will be “materially ahead of current market expectations” with with “strong cash conversion”. They also boost the TI Media synergy target to £20m from £15m by end 2021. Here’s Barclays:
n terms of current market expectations, the adjusted operating profit that they are pointing to is £78.2-83.2m with an average between £80m and £81m. It is impossible to be precise but we think that in general when companies refer to “materially ahead” they are referring to c.10%. If adjusted operating profit were 10% ahead and all other factors remained unchanged, that would imply adjusted EPS 10-11% higher.
On net debt at end FY20, Barclays models £80m and Bloomberg median consensus is £79m. We do not think that management would have referred to “strong cash conversion” and emphasized delivering if the beat in the P&L were not flowing through well to cashflow, so we believe that the commentary suggests that net debt number should reduce. This is reassuring given question marks in the market on some areas of accounting, following a short seller note last year. In a situation like this, the market is extra sensitive on cash and so these comments are reassuring.
On TI Media synergies, £5m extra benefit from synergies would mechanically add 5% to our FY21 adjusted operating profit and adjusted EPS.
Management is not making any other comments on FY21 at this stage, which is unsurprising given that there is significant macro-economic uncertainty in the US and UK on the year to September 2021 and they will very likely wait until FY results on 2nd December before making comments on likely revenue progress in that year.
Overall, Future keeps on delivering better-than-expected progress and we think that this can continue over time. As the group delevers fast, we think that the market will begin to focus on the prospect of further acquisitions which could be notably accretive to EPS, based on what has been achieved so far.
AB Foods’ pre-close update’s fine. Consensus ebit for 2020 moves up about 3 per cent to £990m, with gains equally split between Primark, groceries and ingredients. Credit Suisse can tell you more:
Primark 4Q LFL sales were broadly in line with our -15% forecasts, with UK (-12%) stronger than expected and Europe (-17%) lower, mainly due to the weak Spanish market. Elsewhere ABF had a strong 2H and FY EBIT for all the other divisions will be stronger than expected leading to FY net cash of c£1.3bn which is notably better than expected. We are increasing FY EPS by c1% and leaving our £25.3 target price unchanged. On 16x 2021 PER we believe that ABF shares are significantly undervalued, particularly relative to Primark’s apparel peers and reiterate our Outperform rating.
Primark’s -12% UK LFL since stores re-opened shows that the business is taking share despite the lack of online, and the outperformance vs high street sales (BDO store fashion sales -45% since re-opening) is remarkable, showing the unique appeal of Primark. Excluding 4 city centre stores, UK LFL would have been -5%. The performance in Europe (LFL -17% is softer than we had expected, mainly due to Iberia (28% of European retail space) and big city centre stores, while USA is -9%. With inventory tighter than expected, FY EBIT is expected to be at the upper end of the guided £300-350m range (IFRS 16), ie 6.1% of sales and we maintain our forecast of 8.8% for 20/21, helped by cheaper US$ sourcing. FY net space growth was 0.6m sf (+3.6%) with 0.7m (+4.3%) and 14 new stores forecast for 20/21 making Primark one of the few major apparel retailers with significant M-T space growth potential across most of its markets.
Elsewhere 2H has been stronger than expected with Sugar, Grocery, Agri and Ingredients profits all up Y/Y (CSe +25% Y/Y). Grocery has benefitted overall from greater eating at home due to Covid, but underlying growth rates are robust, and Illovo had a particularly tough year. Overall we would still expect modest growth from non-Primark businesses, including Sugar, next year. We now forecast PBT of £0.9bn (-36% Y/Y) for 19/20 followed by £1.3bn and £1.6bn over the next two years as Primark recovers. We estimate Primark is discounted at £5.7bn, 10x 12m FWD EBIT less than half that of Inditex and H&M, despite superior growth prospects.
In sellside, Panmure Gordon’s down to “hold” on Derwent London:
The period post the EU referendum was one of uncertainty for the London office market with values and rents moving sideways. As a result, the London office REITs traded at a 20-30% discount to NAV, the lack of visibility or any signs of growth putting investors off. However, at the end of 2019 post the general election it felt like there was a clear pathway to growth and the stocks (including Derwent) moved to a premium to NAV in anticipation. This optimism has come to a grinding halt post COVID-19 and whilst we highlighted in our May note concerns about the impact of a wider economic fall-out on the London office market, it appears four months later that a structural change in the way we work might have a bigger impact over the medium term. The net result, whatever the outcome, is a return to uncertainty and a discount to NAV. Therefore, whilst we continue to believe Derwent London looks attractive trading on a 29% discount to NAV, until there is greater clarity of outlook, we see the shares moving sideways and downgrade from Buy to Hold adjusting our target price to 2886p (20% discount to current+1 NAV) from 3556p.
ZYN FY20 cans to 123mn and FY21 to 195mn: Despite capacity constraints in FY20, ZYN has grownUS volumes at ~6mn can/qtr. ZYN is currently distributed in 90K stores out of 150K+ stores. With capacity expansion to be completed in next two months, we think growth can step up with additional distribution. We are 4% & 8% ahead of FY20 & FY21 consensus EPS respectively, even after factoring in adverse FX moves and a California flavour ban.Over the next decade, ZYN US can compound EBIT at 25% per annum. We upgrade to OW and increase our price targetto SEK 800.
California flavour ban passed into law: On August 282020, California passed SB 793 into law, prohibiting flavoured tobacco products from January 1, 2021.California is 7% of US tobacco volume. We include 7% negative impact in ZYN’s 2021 volume forecast, but are still ahead of consensus. The picture at the federal level with H.R. 2339 is complicated. For a flavour ban bill to become law, we will need (a) a Democratic sweep, (b) change to the filibuster process in the Senate, and (c)tobacco to be a high priority for Democrats, which it currently isn’t, with COVID-19 response, healthcare, foreign policy,especially China,and federal tax rate etc. change much ahead, in our view.
Regulation is a risk and an opportunity for ZYN: There are three essential questions when assessing flavour bans: 1) Does it change the growth rate of consumer demand?This requires separating the impact on existing and new consumers considering flavours largely help recruit new users.A flavour ban reduces ZYN’s growth, but not necessarily its existing consumer base. 2) Does it alter the industry structure?A flavour ban would create a duopoly as only ZYN and on! have flavour-free products. 3) How are competing categories impacted?The e-cig PMTA deadline is 9 September. Open-tank e-cigs account for 5% of US nicotine volume, sold largely in flavours, and are seeing significant dislocation as manufacturers struggle to file PMTA. Modern oral is still only 1% of US nicotine volume. Any consumer switching from open-tank e-cigs to modern oral would create a major tailwind for ZYN.Key risks:(a) ZYN penetrates the early adopter demographic and then hits a brick wall, much like IQOS did in Japan in 2018.
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