Broker tips: Thomas Cook, Direct Line, Paragon

Barclays upgraded Thomas Cook to ‘overweight’ from ‘equalweight’ and upped the price target to 90p from 75p following the company’s full-year results on Wednesday.

It said the absence of any earnings per share downgrades, the re-introduction of the dividend and proactive actions to improve Condor profits suggest Thomas Cook may have reached an inflection point.

The bank has been cautious on the stock for two and a half years but noted that margins and cash have improves, with the full-year 2016 results reassuring, while the valuation is attractive.

Barclays said the results were a bit stronger than expected, with a beat in terms of underlying earnings before interest, which came in at £308m versus company consensus of £296m and the bank’s estimate of £297m.

Barclays said that now that the dividend has been reintroduced, there is scope to materially up the payout ratio over the coming years.

The bank pointed out that there are a number of risks to its ‘overweight’ rating. It highlighted low earnings visibility, with heightened geopolitical risks, intense competition, seasonal cash flow and low margins. In addition, it said UK volumes could soften given sterling weakness and Brexit concerns.

“Risks are elevated. However, TCG could surprise with resilient margins in FY17.”

Direct Line got a boost on Thursday as Morgan Stanley upgraded the stock to ‘overweight’ from ‘equalweight’ and lifted the price target to 465p from 414p.

The bank said the company’s shift towards more own brands business and away from partnership business should lead to higher return on equity, greater customer retention and higher-quality earnings.

MS said that as commission costs decline and retention improves, the acquisition costs over the customer lifetime are lower, driving margins higher. It notes expected return on equity to rise from 16% in 2016 to 17.2% in 2019.

In addition, it highlighted Direct Line’s ongoing development and integration of IT infrastructure and said this was a key differentiating factor from other European insurers.

“Year to date, Direct Line has significantly underperformed listed peers, but we believe there is scope for dividend growth to follow the improvement in earnings, with continued special dividends and a gradual rise in the payout ratio over our forecast period.

“We also see earnings from prior year development declining relative to current year earnings, making reserve release sustainability less of a debate.”

Bank of America Merrill Lynch downgraded Paragon Group to ‘underperform’ from ‘neutral’ on valuation grounds.

It noted the shares are up 5% year to date and 20% above their pre-Brexit levels, with Paragon the best-performing UK specialist lender in its coverage.

The bank increased its price target to 360p from 350p. It said the execution of the move is going “extremely well” as Paragon transitions to a retail funded, diversified banking group, but that the transition is not cost free and "substantial uncertainties" within the environment remain.

“While we fully endorse Paragon’s strategic initiatives, as the business mix becomes inherently riskier, and the environment more uncertain, we think there is a limit to where higher leverage can drive a higher equity rating.”

Since the 2008 financial crisis the company has opened other retail funding channels and launched a bank to provide it with new funding opportunities, but this brings increased regulatory scrutiny, Merrill said.

The bank said that the recent acquisition of 5 Arrows, an asset finance business, brings increased diversity, which should help offset a slowdown in Idem Capital, the group's loan acquisition business.