Markets Now – Thursday 2nd July 2020

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For a short period in 1999, visitors to the FT dot com homepage were offered the opportunity to watch London’s Millennium Bridge being built.

The link to the webcam on Internet Archive remains active though it seems the camera has been switched off. That’s a missed opportunity. From the page snapshot above to this morning’s open the FTSE 100 had moved less than 0.3 per cent so two decades watching a bridge would arguably have been a more productive use of everyone’s time.

Markets won’t report themselves, however, so let’s get on with Thursday.

Things are up because there are US jobs data later, which follow some less awful than they could have been EU jobs data. Fans of talking about sentiment also have some interim top-line trial data out of Pfizer partner BioNTech on Wednesday suggesting the most advanced of its four Covid-19 vaccine candidates can deliver immunogenicity. The bigger questions — does it work and is it safe? — require trials involving rather more than 36 healthy patients so will remain unanswered for quite a while. Pfizer says it’ll pick its favoured candidate in the next month then start recruiting for efficacy and safety studies, which generally speaking involve around 30,000 patients.

Is any of this a reason for markets to rally? Was it a reason for Pfizer to rally? No and no. The little data currently available can’t answer any of the big questions and in parts were more of a concern than a comfort. Here’s Barclays:

While the 10ug and 30ug demonstrated neutralizing antibody titers (GMT 168-267) above a reference convalescent sera panel (GMT 94), the titers were roughly in-line to modestly above the FDA benchmark (160) for convalescent sera. Overall, we would argue this a necessary, but not sufficient level of initial evidence of activity to warrant meaningful de-risking of the program. To that point, we would have hoped for greater follow-up, greater evidence of T-cell responsiveness and the characteristics of that response (though BNTX suggested some of this data would be available this month). To their credit, both Pfizer and BioNtech were balanced in characterizing these data, noting repeatedly, these data represent a limited glimpse into the persistence of these neutralizing antibodies. We don’t disagree with their decision to move ahead into larger studies and start large-scale manufacturing, rather, our point is the demonstration of neutralizing antibodies represent a single piece to the story, and that which was most predictable based on prior data with mRNA-based vaccines.

And SVB Leerink:

Safety events were reported after both dose 1 and dose 2. Adverse events were dose dependent, and the rates of fever (defined as ≥38.0 °C) and lymphopenia will be the strongest pushback against this vaccine. These events were frequent enough in the 100 μg group to prevent the administration of a second dose, and were still evident at lower doses. Subjects at all doses in the trial also reported frequent mild to moderate injection site pain, as well as high rates of headache and fatigue. . . . Although the paper describes that these fevers generally resolved in one day and were without high-grade systemic reactions, a commercial product with this profile could be hard to administer to large populations (many of which will not experience any symptoms from COVID-19 itself). . . .

On their call with investors BNTX management acknowledged several open questions, including need for additional correlative work (e.g., characterizing T cell immune responses, long-term durability and safety, the level of immunity needed for effective protection in humans, and differences by patient population). To this list we add whether known mutations in RBD impact neutralizing effect and whether there is a more effective dose between the 30 and 100 ug. They continue the correlative work and promised additional clinical and preclinical publications in the weeks ahead.

UK corporate wise, DS Smith is leading the fallers after releasing full-year results apparently by accident on Wednesday evening. The cardboard football supporter maker misses the upper end of expectations, flags weaker volumes and cancels its dividend. Goodbody can summarise:

From what we can gather revenue of £6.04bn has come in 3% shy of estimates. This implies a 8% decline year on year in H220 (despite the positive contribution of Europac acquisition and new US plant) and is c.5% behind our H220 forecasts. This comes as a surprise given management’s commentary on the resilience of the business as late as April 7th in a trading update. Indeed, volumes look to have declined by c.4% in April, May and June (Northern Europe outperforming West & South) which is below our estimates and box pricing has deteriorated meaningfully to c.-5% in H220.

Group EBITDA has come in at £956m, a c.3% miss compared to both our numbers (and consensus) and a 5% miss for H220. Through a lower depreciation charge (£296m versus £320m guided) the EBITA of £660m has only missed by c.1%. On an organic basis, profits have declined by 13% in H220 compared to 6% in H120. The US has again struggled with EBIT declining by £36m in H2 or 78% yoy. Excluding start up costs for the new plant profits are down c.50%. The US expansion looks to be running at a pre tax ROIC of c.5% highlighting the risks of M&A at the late stage of the pricing cycle. Europac revenues look to have declined organically by over 20% and after its first FY is achieving c.7.5%.

Management notes it will look to resume the dividend in line with greater clarity which we believe will leave investors somewhat wanting given the narrative of resilience in cashflows etc and the trajectory that European economies appears to be on. FY21 exceptionals are being guided to £50m due to further costs associated with Europac and COVID related restructuring while there is a further £30m cost in relation to “COVID specific costs”. Assuming the £50m exceptional is taken below the line and the COVID costs above the line, exceptional charges for FY21 are equivalent to just shy of 13% of our forecast EBIT for FY21.

Overall, there is little to get excited about in these results with top line pressure from both volumes and pricing while costs pressures clearly continue to grow as well. We are downgrading FY21 by c.7-8%. The stock is trading on c.8.5x EV/EBITDA which we believe does not capture the clear downside risk to forecasts, the wider industry and the group’s high leverage and sub-par returns profile. We reiterate our SELL recommendation.

And Numis:

The more cautious outlook for FY21 provides support for our neutral stance on the shares ahead of results, which were principally around the operational gearing impact of volume sensitivity to the macro cycle and the risk that COVID-19 poses to this, which is illustrated by volume declines of 1% and 4.5% in March & April, respectively. With FY20 results coming in 1.5% lighter than our expectations at the operating level, combined with the demand and cost risks to our current forecasts, we retain our stance ahead of today’s presentation despite the optical attractions of an FY21 P/E of 10.5x and an EV/EBITDA multiple of 6.8x.

Meggitt’s rallying on a mostly reassuring trading update. First half revenue’s roughly where it was expected to be as weaponry demand offsets civil aerospace. Liquidity’s moved down a fraction from the first quarter and there’s a disposal just completed so weaker than expected free cash outflow in the first half should reverse by the full year. Here are the thoughts of Jefferies’ Sandy Morris:

What is missing from the trading update is any mention of profitability. JEFe is for 1H20 Group EBIT to fall by 47% from £161.1m to £85.4m and FY20 EBIT to fall by 53% from £402.8m to £189m. That the Civil AM was more resilient in 2Q20 than we expected is perhaps encouraging, but the greater than expected decline in OE revenue may pose a challenge in terms of cost recovery. In general, however, we are always encouraged when a business performs broadly as expected in terms of its revenue; we must just keep our fingers crossed that we got the drop-through from lower sales to EBIT in the ballpark.

Bugbear banished. We suspect it was at either the FY08 or 1H09 results presentations that Meggitt volunteered that it was probably a net beneficiary of lower new aircraft deliveries. In short, Meggitt would continue to enjoy high margin Civil AM demand from elderly aircraft. The comment came to haunt Meggitt, in our view. We believe COVID-19 will finally drive most of the old aircraft Meggitt referred to in 2009 out of service but think it a cloud with a silver lining. One could welcome the equity story being refreshed. We believe Meggitt will re-rate. That is what we would hold onto today even though some expectations for FY20 might be cut.

Bandit favourite Premier Oil is down a bit after saying its creditors have approved the acquisition of BP’s Andrew Area and Shearwater fields in the North Sea on amended terms. The purchase remains conditional on finalisation of a sale and purchase agreement, a debt refinancing, an equity fundraise and approvals from both shareholders and regulators. The next step is for Premier to get a stable platform agreement from creditors and launch a rights issue for about $200m, with a trading update scheduled for July 15 the most obvious opportunity. There are a lot of moving parts here and Premier’s bankers are probably very very busy. Here’s SP Angel:

Whilst we believe that the proposed acquisitions are materially value accretive to Premier and are in line with the company’s stated strategy of acquiring cash generative assets in the UK North Sea, they do come at a considerable cost. At the last trading update, Premier reported a net debt position of US$1.99bn and a half year cash position of US$254m. Assuming the company has to tap into an acquisition bridge facility, Premier’s year-end covenant leverage ratio (currently 2.3x against a covenant of 3.0x.) may come under initial focus. However, we do see the considerable long-term production and appraisal upside of these assets with the cash flow having the potentially accelerate the deleveraging of Premier’s balance sheet.

Completely unrelatedly, here’s a nice bit of O&G fantasy M&A from Peel Hunt (Energean and Premier are excluded from its analysis because they’re already buying things. A hash on the name means Peel Hunt’s house broker):

With Brent up c.80% in two months, E&Ps are slowly shifting mind-set from survival to growth and for cash-rich companies, the opportunity set is increasing. M&A has typically been well received by the market in recent years; understandable given the sector’s chronic shortage of stocks with market cap and liquidity. However, many do not have the luxury of large unallocated cash piles and it can be difficult to raise debt or equity in today’s environment. A merger is an attractive way for these E&Ps to grow inorganically. . . . 

Serica# has been the standout company over the past five years that has added the most value through shrewd acquisitions. The shares are up 18x over this period, achieved without raising any new equity. Going forward, we anticipate Serica will be actively looking to acquire additional assets in the North Sea and continue its measured approach to achieving growth via astute acquisitions.

Jadestone has a track record of making high quality acquisitions at attractive prices eg, we value Montara and Stag at US$400m vs a price paid of US$113m. Despite the recent Lemang announcement, we believe Jadestone has the balance sheet, ambition and shareholder support for another acquisition in 2020/21.

Cairn has a history of pursuing selective M&A at opportune moments to deliver growth (Cairn India disposal, Nautical Petroleum acquisition, Agora Oil & Gas acquisition). Today, it is a solid production and development-focused E&P with a healthy balance sheet and an opportunity to acquire at the cyclical low point.

Sterling Energy# aims to use its US$45m cash (NB market cap is US$30m) to acquire an onshore, low-cost production asset at an attractive price in 2020.

Following the closure of its acquisition of c30Mboe/d Nigerian production, Africa Oil is looking for an additional acquisition. This may be paid for via vendor financing or a deferred cash flow payments structure. Africa Oil is looking for production assets, most likely outside Nigeria to diversify country risk.

Merger candidates from our coverage include: Pharos Energy#/Transglobe Energy and Gulf Keystone Petroleum#/Genel Energy. A merger between Pharos and Transglobe would create an Egypt oil-focused E&P with >£100m market cap and >20Mboe/d oil-weighted production. A Gulf Keystone/Genel combination could also create scale, improve liquidity and make the combined entity more investable than each on a standalone basis.

Elsewhere in sellside, Investec’s Ian Gordon moves up to “buy” on Lloyds:

We continue to see the high street banks as vulnerable given an uncertain political and economic backdrop and/or costly “customer support” requirements. However, with a partial easing of lockdown, we believe the scale of incremental economic damage may start to moderate. Similarly, while banks’ Q2 2020 results will (as previously guided) be adversely impacted by mandated “customer support” measures, the financial burden appears set to ease a little in Q3. Upgrade to Buy (from Hold).

It is difficult to generate any real enthusiasm for large-cap UK banks while they remain at the mercy of a UK economy entering deep recession. That said, recent developments have (arguably) proved “less bad than expected”, with a partial easing of lockdown restrictions on 4 July offering hope that a greater number of private businesses may survive in some form or other.

Alongside Q1 2020 results in April/May 2020, UK banks provided guidance on the likely cost of FCA-mandated “customer support” in Q2 2020. Yesterday’s statement from the Financial Conduct Authority “confirms further support for credit customers”, but the guidelines helpfully remove any notion of “automatic” continuation. To this end, Lloyds has started texting customers to confirm that existing £500 interest-free overdrafts will revert to normal terms from 10 July, i.e. the onus is on the customer to request further assistance if required. Other things being equal, we would expect this to lead to a lower Q3 revenue drag.

We also expect investors to draw moderate comfort from the FCA’s “update on banks’ overdraft pricing decisions and plans to support customers”. The FCA had written to banks in January asking them to explain how they had reached their new overdraft rates (set in response to new FCA rules published in June 2019). Yesterday, the FCA stated inter alia that “having reviewed the evidence we obtained we do not intend to open a formal investigation at this stage”. Banks can at least be grateful for that!

The Lloyds share price has fallen by 17% over the past 17 days; it is now the worst performing FTSE 100 bank share for 2020 year-to-date (Fig 2, page 2). We cut our TP to 36p (from 37p), but trading on just 0.53x Q1 2020 tNAV for ROTEs of 4.6%/6.2%/7.7% in 2020/21/22e, we now upgrade our rec to Buy (from Hold). At this level, Lloyds becomes our preferred large-cap UK bank.

Deutsche Bank goes up to “buy” on Rio Tinto and down to “hold” on BHP:

We upgrade RIO to buy, replacing BHP (downgraded to HOLD) as our preferred iron ore major. In our linked report (Can Mining & Steel Sustain in a low carbon world? – 1 July) we take a deep dive into the decarbonisation challenges facing the sector. We believe RIO’s portfolio is better positioned for the long term and, in the shorter term, RIO offers compelling near term cash flows and cash returns. As outlined in our recent reports , our 12 month outlook for the sector remains positive. Aside from short term seasonal risks, we expect iron ore prices to remain elevated in 2020 and 2021 (DB $90 / $85/t) due to China stimulus and ongoing supply constraints (we are >15% ahead of consensus 2021 EBITDA). RIO is trading on a 2020/21 FCF yield of 9-10% and DY of ~8% (60% payout assumption with upside potential), attractive vs peers. BUY for long term resilience, clear strategy and market leading cash returns.

Three key drivers to our [BHP] downgrade: (1) Portfolio: In our linked report (Can Mining & Steel sustain in a low carbon world? – 1 July) we take a deep dive into the decarbonisation challenges facing the sector. We have revised our long term steel demand projections and lowered our long term coking coal price forecasts. BHP has the lowest exposure to energy transition metals (~80% EBITDA is iron ore, coal and petroleum) and the greatest downside risk under a rapid decarbonisation scenario. (2) Strategy: BHP is committed to diversifying away from steel raw materials and reinvesting in petroleum and potash. This makes for a more complicated climate strategy vs. peers. The lack of transition metals exposure could lead to the company pursuing higher risk projects and potentially M&A. (3) Valuation: We upgraded BHP to BUY in March, a value call following an aggressive, Covid-19 induced sell-off (Fig 4). BHP is now the premium rated miner reflecting cost position and diversification; will the company’s coking coal and petroleum exposure garner a premium in the years ahead as ESG integration spreads and the terminal values of fossil fuel businesses are put under even greater scrutiny? We downgrade to HOLD and reduce our TP from £17.5 to £16.5.

Peel Hunt takes Auto Trader down to “add” from “buy”:

Post-prelims, we confirm our revised forecasts in line with the indication given on the day. The main change to our FY 21 forecasts is the revision to June’s indicated level of customer support: we had assumed a 100% invoice discount rather than the 25% now offered. As a result we upgrade FY 21 PBT/EPS 12% to £169.0m/14.2p. We downgrade FY 22 5.4% to £263.7m/22.3p, based on a more protracted expected recovery. However, we increase our TP from 545p to 560p, to reflect the increasing likelihood in our view that the proceeds of the fundraise will be used for strategic rather than defensive ends. Following the recent rally we move from Buy to Add.

National Grid is cut to “hold” at HSBC in a very belated post-results note:

Cash flows and debt remain the focus: NG announced that net debt is set to rise by GBP3bn in the current year. Therefore, it said its key credit metrics are unlikely to meet the minimum required by Moody’s for an A3 rating. Because this shortfall is highly likely to be recovered in future rates case adjustments in the US, this should be a temporary situation, according to management. With NG’s debt increasing and pension deficit expanding, management plans to rely on scrip dividends to reduce cash payments; however, with a dearth of dividends in the UK, take-up of the scrip may be low this year. On 9 July 2020, Ofgem is to announce its draft determination for the UK transmission price reviews. NG has ambitious investment plans, but lower returns and regulatory adjustments may be a challenge.

Equity analysis and ‘value added’: We have analysed NG’s fundamental performance, using its own ‘value added’ metric, which encompasses RAV/US rate base additions and investments in non-regulated growth, dividend payments and debt growth. Momentum appears to be slowing.

Downgrade to Hold and trim target price to 1,000p from 1,060p: We value NG using three methodologies: DCF, dividend yield and a sum-of-the-parts approach. We assign a 50% weight to yield and 25% each to DCF and SOTP to arrive at our new target price of 1,000p (from 1,060p). We cut our estimates; increase the yield premium in our yield valuation to reflect dividends not supported by any cash flow yield; and reduce the US peer group multiples in the SOTP. Combined, these changes result in the cut to our target price. We downgrade to Hold as we see limited upside at the current levels as NG has limited financial headroom because of the short-term impact of the COVID-19 outbreak on its earnings while it also needs a supportive price control from Ofgem and scrip take-up to support its balance sheet.

And Heineken goes to “neutral” at JP Morgan Cazenove:

We downgrade Heineken to Neutral (from Overweight) ahead of likely very challenging H1 2020 results on 3 August. Due to mix, top-line pressures and FX, we reduce our 2020E EPS by c17% with c6-7% cuts to 2021/22E. For FY 2020, we now expect -7.6%/-9.6%/-22.5% organic volume/sales/EBIT declines driving EPS down 31% yoy to €3.02. Though the outlook should sequentially improve following the tough H1 (-15%/-19%/-45% organic volumes/sales/EBIT), significant top-line and earnings risks remain. Valuation on 27x/20.3x is broadly in line with the sector and ahead of beer peers, limiting scope for outperformance. We reduce our Dec-20 price target to €80.00 (from €83.25) reflecting our reduced estimates and a 5% sector P/E premium. . . . 

Premium unlikely to outperform in a COVID-19 world. While Q2 is likely to represent a low-point in volumes impacted by widespread COVID-19-related on-trade (c35% of sales) and selected brewery closures (e.g. Mexico, South Africa), the path to recovery is unclear with significant downtrading risks, especially in emerging markets, negating the prior four years of premiumisation-led top-line outperformance. Within developed markets, where aggregate beer volumes have held up better, revenue/HL in off-trade channels can be meaningfully lower vs the on-trade along with margin-dilutive product format mix. Even with the gradual formal re-opening of on-trade outlets, we would expect formal or informal social distancing to limit on-trade sales for the rest of 2020. On the margin side, Heineken has historically invested ahead of premium beer growth in its markets limiting scope for cost flexibility near-term to manage the demand hit and mix impact. The recent CEO transition could offer an interesting mid-term opportunity for the equity story, though we believe it may be too premature to play amid the sharp deterioration in the earnings profile.

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