Broker tips: Asos, Superdry, Serco, Weir

RBC Capital Markets downgraded Asos to ‘outperform’ from ‘top pick’ on Wednesday, slashing the target price to 3,200p from 7,700p "while uncertainty shadows the stock" following the online retailer’s shock profit warning earlier in the week.

RBC said it has underestimated Asos’s vulnerability to a more promotional market. The bank said it was reducing its estimates by 55-60%, hence the target price cut, to reflect the "new reality", although having assessed the risk/reward, it is compelled by the opportunity the current share price creates.

It removed the stock from its ‘European Equity Large Cap Best Ideas’ list.

The business model isn’t broken, but the macro risk has heightened, RBC said.

"The industry backdrop has significantly deteriorated in 2019, and despite its structural tailwinds, Asos is evidently not immune. However, we continue to believe that its industry-leading proposition…and pace of innovation will enable Asos to continue taking share in its large addressable market."

Asos shares tanked on Monday after it downgraded its guidance for the year as weaker trading in November and heavy discounting took their toll.

The company said increased discounting, coupled with the unseasonably warm weather during the last three months reduced its average selling price, which has not been compensated by higher units per basket. As a result, average basked value is now lower year on year. This has driven higher variable costs through both its distribution and warehouse cost lines.

UBS started coverage of Superdry with a 'neutral' rating on Wednesday and 500p price target, saying the stock looks fairly valued.

It noted that Superdry's price-to-earnings has contracted from 16x to 7.5x year-to-date as decelerating group sales growth, from 22% per annum to 2% in FY19E, has sparked debate over the company's growth potential. After adjusting for growth and returns, the shares now appear fairly valued relative to European apparel peers.

"The longer-term drivers for Superdry are clear to us, namely: (1) a strong brand (confirmed by UBS Evidence Lab UK consumer survey results); (2) range extension opportunities; and (3) plenty of market share to go for internationally," UBS said.

However, as Superdry works through its product imbalances, it expects a moderation in sales growth to 4% FY18-22 compound annual growth rate and limited upside risk to the market's mid-term growth expectations.

UBS said Superdry is on the cusp of delivering some important product developments and once complete, these will position the brand well for future growth. However, the bank's case study analysis of four more established brands shows the challenges for Superdry are that customer perceptions take time to change and execution risks are high against a backdrop of volatile industry demand.

"As management executes against its product strategy over the next 12-18 months, we see limited scope for earnings upgrades," it said.

Peel Hunt upgraded Serco to ‘hold’ from ‘reduce’ on Wednesday as the current share price is close to its new target price of 100p, up from 87p.

Following the outsourcer’s pre-close trading update on 13 December, the brokerage confirmed its 2018-20 forecast adjustments. Its 2018 pre-tax profit estimate is unchanged at £79m, while its earnings per share estimate increases by 6% to 5.2p due to the reduction in the tax rate to 25% from 29%.

Peel’s forecast for 2019 pre-tax profit increases by £2.8m to £81.0m to reflect a £0.8m increase in EBITA, which places its forecast in the middle of the £95-100m guidance range.

The primary driver of the upgrade to EPS forecasts is lower effective tax rates, which reflect the improvement in and mix of profitability. Leverage and net debt are also expected to be lower than previous guidance, Peel said.

Peel noted that the shares trade on 18.0x 2019 EPS estimates as the market attempts to value Serco using an assessment of recovered earnings in the medium term.

"When the UK business returns to sustainable profitability some or all of these tax losses will be recognised and utilised, and the effective rate of tax will be reduced, potentially below the 20% rate we currently assume in the medium term," it said.

Goldman Sachs has reinstated its rating on Weir Group, arguing that the headwinds currently weighing on the stock should ease in 2019.

The bank has a ‘neutral’ rating on the FTSE 250 engineer with a price target of 1,750p.

In November, Weir said full-year profits in its oil and gas division would be hit by a slowdown in activity in the US shale market caused by capacity constraints in the Permian basin.

Goldman Sachs said in the note published on Wednesday: “Permian pipeline constraints led to oil and gas customers deferring demand and lower oil prices raised doubts about the speed of a 2019 recovery. China concerns have led to mining equipment players de-rating by around 30% year-to-date.”

The bank cut its estimates for Weir’s earnings before interest, tax and amortisation by 8% for 2019 and 4% in 2020 on a like-for-like basis.

But it added: “These headwinds should ease next year. We expect extra pipeline capacity to come online in the second half of 2019, and while the pace of recovery for Weir’s North American oil and gas business is uncertain, our sum of the parts analysis suggests the market is only paying 5 x 2020E EV/EBITA for oil and gas.”