Markets Now – Tuesday 14th July 2020

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How many interesting things are there to say about Halma? It started out as The Nahalma Tea Estate Company. Its headquarters in Amersham are just down the road from where the Lollard martyrs were burnt at the stake during the reign of Henry VIII. It owns a company called Longer Pump. The Debrett’s listing for David Barber, who in the early 1970s transformed Halma from a niche engineer into a niche engineering conglomerate, says he spent two years in the Lancashire Fusiliers.

All of these things are much more interesting than Halma’s full-year results, which are in line with a slightly cautious outlook, but on a dull day for corporate we can only work with what’s available. Second half pre-tax profit of £138m is exactly in line but the 2021 guidance suggests a 7 per cent cut to consensus at the midpoint. The shares, having been very expensive going into the results, are now slightly less expensive. Morgan Stanley can summarise:

Halma reported FY20 sales of £1,338m (4.8% organic growth) 0.6%/0.7% ahead of consensus /MSe, EBITA of £279.2 1.5% ahead of consensus and in line with MSe and adj. EPS of 57.4p which is 2%/1.7% ahead of consensus/MSe. Cash conversion was 97% (vs. 85% KPI with 5% boost from IFRS16 and 2% from provision impact) and Halma has proposed a dividend of 16.5p, up 5% YoY.

Process Safety: Organic sales growth of -1.7% vs MSe -1% with good progress in the Industrial Access Control and Gas Detection subsectors, but Pressure Management revenue and profit declined, reflecting a challenging US onshore market, and Safe Storage and Transfer suffered from customer project delays due to COVID-19. Margin came in at 22% vs MSe at 23.8% as a result of mix (US O&G higher margin).

Infrastructure Safety: Organic sales growth of +3.1% vs MSe +4% reflecting planned reduction in low margin businesses in 2H. Margin came in at 23.1% vs MSe at 22.3%. Medical: Organic sales growth of +3.3% vs MSe 3% and mixed trends in the different subsegments. Margin came in at 24.3% vs MSe at 23.8% as a result of mix.

Environmental & Analysis: Organic sales growth of +13.6% vs MSe+9% supported by new product development and by regulatory requirements in the UK water market, and in Optical Analysis. Margin came in at 21.4% vs MSe at 22.9% driven by mix and some provisions for bad debt.F1Q21 trading update: Revenue was down 4% reported and -13% organic with weak O&G and Infrastructure Safety and pushouts of elective surgery affecting Medical but continued growth in Environmental and Analysis.

Outlook: “Timing and profile of recovery remains uncertain; currently expect Adjusted profit before tax for FY2021 to be 5%-10% below FY2020 (today’s results = £267m; FY21 consensus currently £264m), and more weighted to the second half than in previous years.”

Conclusion: FY20 marks another Record Year of Revenue, EBITA, EPS and DPS for Halma with strong execution across all divisions and a robust cash conversion. The M&A strategy appears intact with 10 acquisitions closed during FY20 adding 5% to sales and adj. PBT. Halma noted the M&A pipeline remains healthy although does not expect to close any acquisition in F1H21.We expect the shares to be down on the back of the results, given they currently trade on FY21e EV/EBITA of 27.3x and EV/sales of 5.8x ie currently appear priced for perfection

Elsewhere . . . Britain’s confirmed it’s banning Huawei stuff from 5G networks. The ban will be applied in two stages from the end of 2020, with new equipment purchases not allowed from after December and networks fully de-Huawei-fied by 2027. Vodafone and BT are both up on what looks like good news, at least relative to the press reports that Huawei kit might have to be stripped out within two years. Here’s Neil Campling of Mirabaud:

The initial ruling in the UK was that Huawei equipment could be present in up to 35% of the country’s 5G network (but not the core), but the government has been backtracking after US pressure. GCHQ’s National Cyber Security Centre (NCSC) is also reported to have reassessed the risks posed by Huawei (and is probably concerned about the risks to the 5-eyes alliance if there isn’t a change in policy).

Vodafone has said it would cost billions to rip out and replace Huawei and it would delay the rollout of 5G. Together with BT the carriers have been reported as requesting for 5-7 years to remove Huawei equipment and prevent blackouts – whereas media outlets suggest it could be a time limit of 2 or 3 years. Andrea Dona, Vodafone U.K.’s head of networks, said if the government decides to strictly ban Huawei it would cost Vodafone “low-single-figure billions” to swap out its thousands of Huawei stations and antennas across the country according to Bloomberg. This certainly feels like an exaggeration if truth be told. . . . 

In the nonsensitive radio access network, Huawei are an important supplier to both Vodafone and the overall industry, reflecting the high-quality technology. RAN quotas, which require swapping out a modern 4G network were described as risking disrupting customers, could drive higher prices given the costs involved, and most importantly, would delay the rollout of 5G by 2 to 5 years, given the industry’s limited operational and financial resources. So the fact that existing infrastructure can be replaced gradually over the next seven and a half years is not as impactful as first feared.

Looking at Vodafone’s capex; we can see at the group level that the company spent €5.2B on capex in FY20. If we use a simple calculation of breaking down capex according to individual country service revenue then we would get to an annual UK capex spend in the region of €550m. In FY20, for example, Vodafone spent €2 on maintenance, and €1.50 on capacity for every €1 spent on new coverage. So the idea that ripping out Huawei in the UK would cost billions and billions seems sensationalist and perhaps, politically charged. Overall, today’s statement is a watered down risk relative to expectations and Vodafone are well positioned to navigate their way around policy changes.

Regular readers will know already that it’s Fevertree, not Fever-Tree. This is the tiny hill on which we’ve chosen to die. Until this year the tonic water maker would qualify its chosen name in announcements with quote marks, like this:

Now, however, it just straight-up lies:

There’s no such company! It’s Fevertree Drinks PLC! Fevertree had an opportunity to add a hyphen in 2014 but didn’t. If they really want to be known as Fever-Tree Drinks they’ll have to fill out the NM01 and pay another £10 processing fee, and until the paperwork is in order we’ll continue to deadname. Fevertree Fevertree Fevertree.

So anyway. The upshot of a trading statement is that home drinking compensated for pubs being closed earlier in the year, but the trend’s now reversing and gross margins will suffer. There’s no proper guidance and few useful numbers. There’s an acquisition, however, with Fevertree buying its German distributor for £2.6m cash. Owning capital intensive stuff like distribution was never the idea for Fevertree so it feels like a move forced by necessity rather than design.

Here’s Jefferies to flesh it all out a bit.

Fever – having a good C-19. We have previously highlighted that Fever is having a good C-19. The business is fit for purpose given the strong b/s and low fixed cost base, and the step up in home consumption in the US during lockdown has provided a tailwind for premium mixers to become part of the drinking repertoire. The key question is how sticky these consumption habits are in the US post lockdown and whether building the brand in the off rather than on-trade could impact LT prospects.

1H trading update. The company has provided colour on trading by region over the past 12 weeks. Whilst it is hard to conclude on a 1H revenue number, the destock in Europe implies that our estimate, Jeff £112m, could be a little high. We expect consensus £104m to be broadly unchanged.

Opex – investing through COVID-19. Company is maintaining its planned investments, in particular on marketing, and intends to maintain its budgeted £60m opex for the FY. Although this takes away some potential cushion to protect profitability, it will likely be taken as a positive given investment through the cycle.

UK – robust off-trade. On-trade is 50% of UK sales, severely impacted by the lockdown. Off-Trade has been strong with +34% growth over the past 12 weeks, with spirits also strong +26%. Favourable weather has also helped. On-trade reopenings started 4 July, but recovery is slow and visibility on the rebuild is low. Some recent data from managed pubs indicated that 42% of pubs and bars opened on the 4th July w/e; of those that opened, trade was -45% vs prior year w/e.

US – strong off-trade. Off-trade is 70% of sales. Last 12 weeks +89% in the off-trade. Benefits include (1) incremental distribution gain from distribution won (esp June 2019). (2) Switching from on to off (3) Increased trial and strong tonic growth (4) Price repositioning coming on-shelf. The on-trade recovery varies state by state. Texas, Florida, and now California are going back into lockdowns.

Europe – some destock. Europe is 45% on and 55% off. Although the off-trade has performed well, sell-in has been below sell-out given both distributor destocking as well as Fever managing credit control carefully. We would expect a shipment catch up into 2H with July orders looking strong, however, the destock will weigh on 1H performance.

German deal – logical evolution of RTM. Company announces the acquisition of its sales agent in Germany, Global Drinks Partnership (GDP), the distribution partner over the past seven years. Financial impact limited. The German mixers category is growing 4% vs Fever 25%. The transaction is not a change in strategy but represents an evolution of the route to market to help tackle a sizeable med to long term opportunity here.

As for the acquisition, here’s Liberum:

While clearly distribution businesses have different economics from brand-led outsourced mixer-cos, route-to-markets are incredibly important for beverage companies. In our experience, investors and analysts often underappreciate the importance of a strong route-to-market. There are many examples of brewers, in particular, who have significantly improved their inmarket performance when they acquired the agents handling their route-to-consumer. While we believe the German market is healthy for Fever-Tree, we believe this will further strengthen the company’s competitive advantages in the region and enable Fever-Tree to provide better service levels to its customers, thus helping it capture the opportunity ahead.

Germany is the largest mixer markets in Europe by a long shot and remains a notable opportunity for the group. The size of Germany is not quantified but it could be 15-25% of Fever-Tree’s sales in Europe. The acquisition comes with established management, distribution relationships and sales channels already in place to accelerate the strength and depth of its presence. FeverTree has worked with GDP for 7 years.

GDP also distributes premium beer and spirit brands, which generated €10m of sales in 2019. The group will be working with these brands in the future. The brands include Staropramen, Estrella Damm, Tiger beer, Aspall Suffolk Cidre, Edinburgh Gin, Martin Miller’s gin, Beluga vodka. Fever-Tree works closely with Spain’s Grupo Damm, the maker of Estrella Damm, in the Spanish market. For this reason, we think it is reasonable that Fever-Tree will remain committed to the beer category and specifically Damm.

The acquisition was EUR 2.6m of cash plus a EUR 5m consolidation of historic balances owed to Fever-Tree by GDP at completion. Fever-Tree has agreed to fund the repayment of EUR 1.9 of shareholder and other loans owed by GDP.

RBC’s upgraded Restaurant Group to “outperform”, 80p target. Shutting down a large number of Frankie & Benny’s and Chiquitos should benefit shareholders almost as much as diners, they argue:

Our view: COVID-19 has been a catalyst for RTN to accelerate its 5-year restructuring program into 5 months, positioning it well for the recovery. We believe investors should be able to look through the legacy Leisure business now, and focus on the growth areas – in particular Wagamama.

Key points: The accelerated restructuring has reduced the no. of units by 1/3 including over half of the tired Leisure units (130 from the CVA & 60 from the administration of Chiquitos). The 160 Leisure units that remain are the more profitable sites, and will benefit from more favourable rental terms. Within the growth business, the group also exited 30 concessions that would have been cash negative given the lingering impact of COVID-19 on passenger travel. The pubs operation is well positioned with £150m of asset backing, but has also benefited from estate management with the administration of Food & Fuel (12 sites).

EBITDA mix is now increasingly skewed towards the growth business. We estimate the proforma group, post-restructuring, would have produced £124m EBITDA on £795m revenue, compared to £137m EBITDA on £1073m revenue reported in 2019. However, by FY22, we forecast Wagamama will account for 54% of EBITDA (vs 44% in FY19), with Leisure declining from 24% to 17%.

The group was quick & decisive to arrange additional liquidity to help finance the recovery. It raised £55m from a 19.99% placing, and has taken out a £50m loan from the government-backed CBILS scheme. The lending banks have also waived covenants until June 2021. We estimate RTN has £120m headroom in its facilities, putting it in a strong position relative to struggling casual dining peers. Capacity is likely to reduce in the wider market, although it is too early to say when, and for how long.

New forecasts err on the side of caution: We have cut FY20 EBITDA from £46m to £26m, factoring in a £15m benefit from the VAT cut (we assume 50/50 retained vs passed on to the consumer). We forecast a 45% LFL sales decline for the year, retaining our -45% forecast for Q3 and downgrading from -10% to -20% for Q4. Interestingly, Coffer-Peach data suggests the Super Saturday weekend saw restaurants that were open trade at -44% LFLs YoY. Overall, we expect Wagamama & Pubs trading to recover to 2019 levels in 2022, with Concessions in 2023.

On valuation, the stock trades at 10x FY22e PE. We use FY22 as this is the first year that we expect to return to more normalised trading, and it will also not be impacted by government stimulus that will benefit FY20/21. This is at the lower end of RTN’s historical 8-17x range. Our SOP model suggests a PT of 80p based on 10x EBITDA for Wagamama, 7x for pubs, 6.5x for concessions, and 5x for Leisure. Given the current share price, we believe RTN offers attractive value and upgrade our rating to Outperform

Still with RBC, engineer IMI goes up to “outperform”.

Our view: We have always had a positive view on the restructuring potential in the group, but this was previously countered by cyclical and partly structural headwinds. While some headwinds remain, with focus moved beyond 2020E the significant self help-potential can drive the investment case for a share trading at the low end of its 30 year sector relative rating range.

Key points: Long term potential – IMI has past peak margins in all three of its divisions close to, or above, 20%. However, group margins fell significantly through to 2016 and settled still >400bps below their 2013 peak (2020E 13%). Roy Twite became CEO in 2019 and has outlined a strategic plan to lift all three divisions back in the direction of 20% operating margins. With peers that operate at over 20% in all three divisions we see this as feasible. Total cost savings are already targeted at c300bps on 2019 sales to support this uplift. This would be combined with a return to a more dynamic pricing strategy that was successful in the past. We forecast operating margins rising back to 16% in 2023E despite the near term cycle headwinds.

Short term cost actions supportive – Covid is an added headwind, but with IMI already cutting costs, they announced at the Q1 update 2020E benefits increasing to £28m (from £25m before) as part of a total program aiming to deliver £58m of savings (with a further £30m of other temporary cost containment initiatives in addition). We see more as possible and the H1 results on 24 July could see a further update.

Trading at low end of 30 year range versus the sector: Our price target for IMI is raised to 1140p (from 1000p). This is based on a P/E of 14.5x 22E, set in line with IMI’s 5-year average P/E. The current P/E relative to the sector at a c30% discount is at the low end of the 30 year trading range. At 14.5x the discount would still be 20% in 2022E vs both the 5 year and 10 year average discount at c10%.

Centamin’s down to “hold” at Berenberg on a change of lead analyst:

• Centamin reported a solid quarter at the company’s Sukari mine in Egypt with production of 130koz versus consensus of 116.8koz and Berenberg’s estimate of 114koz. There was no meaningful impact from COVID-19 during the period beyond travel restrictions to and from Egypt and some inventory build. The production beat was driven by higher-than-forecast grade from the underground mine with some higher-grade stopes brought forward and better-than-expected plant throughput. Costs also beat our expectation, with cash costs of USD625/oz (Berenberg USD723/oz) and all-in sustaining cost (AISC) of USD900/oz (Berenberg USD1,001/oz). The beat was driven by higher production. Management reduced maintenance at the plant in H1 due to difficulties with getting expats into the country so there will be a need for more prolonged downtime in H2. Cost guidance has not been changed at USD630/oz-USD680/oz (Berenberg USD636/oz), with AISC guidance of USD870/oz-USD920/oz (Berenberg USD903/oz). The guidance for the year has been trimmed from 510koz-540koz to 510koz-525koz. In terms of the physicals, the open pit was very similar qoq with 4,122kt mined at 0.98g/t. Mining was focused on the higher-grade Stage 4 North and West areas of the pit. The underground mine, however, reported a 9% increase in tonnes to 168kt with a 20% rise in grade to 5.99g/t, with ore principally sourced from Ptah. Recoveries through the plant were flat at 88%.

• Balance sheet remains very strong: Centamin finished the quarter with USD367m, down from USD379.2m at the end of Q1, although this follows the payment of the USD69m interim dividend in May. We expect Centamin to finish the year with no debt and USD313m of cash, with USD302m of FCF. We believe that Centamin both retains the flexibility to be acquisitive and to maintain a high level of distribution with DPS of USD0.19 expected for the year. We expect H1 EPS of USD0.0765.

• Price target tweaked up to GBp200, cutting rating to Hold: Our price target moves to GBp200 from GBp190 based on 8x EV:EBITDA and 1x NAV. We move from a Buy recommendation to a Hold. We believe that the shares are now trading at near to fair value and that H2 should be weaker than H1 due to lower plant availability. We expect production for the year of 521koz at a cash cost of USD636/oz and an AISC of USD903/oz. 

And Deutsche Bank has a big note out on the UK banks, which goes:

Prepared for the Precipice; Resuming Coverage and Target Price Change: HSBC Holdings – Resuming with Sell, tgt 335p, Lloyds Banking Group – Resuming with Hold, tgt 34p, RBS – Resuming with Sell, tgt 100p, Standard Chartered – Resuming with Hold, tgt 415p, Virgin Money UK plc – Resuming with Buy, tgt 105p, Barclays – Buy, tgt 208p to 135p.

The uncertain path of UK and US interest rates, unemployment and real money growth drives our cautious stance on the UK banks overall. We are 7% below consensus on NII by 2022. UK banks valuations are low (0.46x 2022e TBV and 6.4x P/E) but only trade at a modest discount to European banks (0.52x and 7.1x). In this environment we prefer the income diversity of Barclays (BUY,) and the relative rate insensitivity of VM (BUY) over the more revenue impacted RBS (SELL) and LLOY (HOLD). Similarly, we prefer STAN (HOLD) over HSBC (SELL) due, in part, to the less rate sensitive business model and greater flexibility in the cost base.

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