Broker tips: Aviva, Diageo, Astrazeneca

Recent underperformance led analysts at Credit Suisse to remove Aviva from their Europe Focus List, but they expected the stock's price to close the gap versus its peers over the next few years.

The decision to remove the stock from that list was triggered by the shares' breach of the 'stop loss' of 10.0% relative to its sector, R.Burden said in a research note sent to clients.

However, he expected the company to be able to continue strengthening its balance sheet thanks to steadily improving cash remittances from key subsidiaries to the group.

Capital synergies from the Friends Life integration and further capital release from potential disposals of peripheral businesses such as its french banc-assurance joint-venture with SocGenor the group's Spanish operations.

As a result, management would have the opportunity to either drive growth by enhancing its core operations or return additional capital to shareholders, above and beyond the expected dividend.

That should see the valuation gap between Aviva and its rivals L&G and RSA close over the next few years as management continues to demonstrate execution on capital management.

Burden stayed at 'outperform' on shares of Aviva, sticking to his 620p target price too.

Shares of Aviva were then changing hands on about eight times the broker's forecast for its operating earnings per share in 2017, versus approximately 10 times EPS for L&G and 11.5 times over at RSA.

Morgan Stanley issued an ‘overweight’ rating on Diageo on Tuesday, saying the company was its “top pick” among beverage makers.

The financial services firm said it expects Diageo to increase is its share in the US spirits market and demand to pick up sharply in Asia and Latin America.

“Diageo continues to deleverage and focus on its core spirits portfolio. This leads to +6% organic sales growth in full year 2016 and 8% organic earnings before interest and tax growth (EBIT),” saidMorgan Stanley analysts Olivier Nicolai and Richard Felton.

The analysts said the maker of vodka brand Smirnoff should see EBIT margins improving 100 basis points between 2017 and 2019 following a £500m cost savings programme in July.

They also expect positive transactional foreign exchange in the US to add £60 to EBIT before reinvestment as they estimate 55% of Diageo's sales are imported products.

The strong balance sheet, with net debt expected to fall in 2016, also offers buy back optionality in the next 12 months, they added.

“We are 5% ahead of consensus for full year 2017 and believe earnings upgrades should trigger a re-rating. Diageo trades on 18.5x calendar year 2017 price to earnings ratio and offers 5% free cash flow yield and 3% dividend yield.”

Morgan Stanley set a target price of 2,200p, based on a discounted cash flow valuation in which they assume a 6.5% weighted average cost of capital and a 1.5% terminal growth rate.

Goldman Sachs downgraded AstraZeneca to ‘sell’ from ‘neutral’ and cut the price target to 3,700p from 4,400p saying current long-term estimates are overly optimistic.

Goldman said the company has a strong pipeline of new medicines but, as ever with pharma, there is a certain amount of uncertainty associated with the clinical success of pipeline development and commercial success once the products are launched.

It sees three key potential areas of downside: below-consensus estimates for the base business and pipeline, limited M&A flexibility, and relatively high valuation.

For 2020, the bank is 10%/20% below consensus on revenue and earnings per share.

Goldman said AZN’s core earnings benefit disproportionately (relative to EU peers) from income streams associated with asset disposals and product out-licensing.

“At the current stock price, we forecast AZN’s implied IRR on its R&D investment to be 9%-12%, significantly higher than that discounted for the peer group (2%-3%); this suggests to us that that the current stock price already discounts significant pipeline success.”

Goldman made it clear the downgrade reflects its view that at the current price, there are better risk-reward ratios across other European pharma names, including Roche, Novo Nordisk and Bayer.

For investors looking for UK exposure, it said GlaxoSmithKline offers a meaningfully better risk-reward, with a higher estimated dividend yield over 2016-17, supported by higher real cash dividend cover.