Broker tips: Ocado, HSBC, Compass
Ocado was trading sharply lower on Wednesday after Exane BNP Paribas downgraded the stock to ‘underperform’ from ‘neutral’, keeping the price target at 215p, as it pointed to margin pressure and said the market’s expectations for profitability were too high.
The bank said its gross margin assumption was the most important it makes in its Ocado model and once again, it expects it to be down in the second half.
Exane said that with the next couple of years burdened by new distribution centre costs, earnings progression will fall short of market expectations. “More importantly that weak earnings development may cause a potential new partner to return to their spreadsheet and think again.”
“With enough volume, Ocado may have the world’s most efficient food picking model but it needs big basket shoppers with good gross margin to make a profit. Gross margin however is dictated by painful industry forces and Waitrose’s pricing policy (even if it can’t dictate Ocado’s prices directly).”
In addition, Exane said progress in earnings before interest and taxes was likely to be subdued in the next three to four years.
“Because we doubt that the gross margin tension we’ve seen in recent periods will unwind quickly and that new capacity costs will impinge cost to serve, we doubt that group EBIT will see meaningful development.”
The bank said it was also worth noting that part of the Morrisons.com partnership income will drop out in 2018 too. It pointed out that this was worth around £5m a year, although it is partially compensated for by growth at Morrisons.com.
JPMorgan Cazenove upgraded Compass Group to ‘overweight’ from ‘neutral’ and lifted the price target to 1,580p from 1,380p.
“With the 20.5% year-to-date rally predominantly reflecting 12.3% FX upgrades, a marked underperformance since July, and the stock still trading in line with consumer staples on 18.7x CY18e price-to-earnings, we upgrade Compass shares to an overweight rating.”
The bank said Compass was likely to have delivered its smallest buyback on record in the year to September 2016, at only £99m or 0.4% of market capitalisation.
However, JPM sees £460m of free cash headroom in full-year 2017.
JPMorgan reckons Compass can continue to deliver 6-7% constant currency earnings per share growth driven by 4.5% organic growth and around 10 basis points of margin improvement.
“Ongoing improvements in new business and retention should cushion any further deterioration in LFL, and we are neither worried about employment volumes (2006-2015 contribution 0%) nor food deflation risks (excellent track record, contract pricing also includes labour).”
UBS downgraded HSBC to ‘neutral’ from ‘sell’ but nudged up the price target to 540p from 535p, with modest capital downside offset by dividend yield.
The bank noted HSBC’s share price is up 17% in sterling since early August, adding $25bn to its market cap and prompting investor interest in the stock.
This puts HSBC’s forward price-to-earnings at its highest level since 2010, which UBS said was a healthy premium to relevant peers such as the Eurobanks sector and Citi.
“We see little in the operating environment and conversations with investors to justify a further re-rating of the stock in the near term.”
UBS said HSBC was not a ‘sell’ however, with recent results confirming progress on costs and sufficient confidence on capital to confirm plans to pay a 51 cents per share future dividend and launch a $2.5bn share buyback paid from the proceeds of the Brazilian disposal.
“On the analyst call management suggested, we think, that another buyback may be forthcoming if HSBC succeeds in releasing capital trapped in the US since the Capital One sale in 2012. In a world of low yields and capital concerns, we view decent income and non-UK exposure as attractive features of the stock.”