Broker tips: B&M, Capita, Barclays

B&M European Value Retail’s shares received a boost on Wednesday after Canaccord Genuity raised its rating on the stock to ‘buy’ from ‘hold’ and lifted the target price to 295p from 265p.

Canaccord said it remains positive on the variety retailer’s UK prospects and is “sanguine” on concerns about the retail market following Brexit’s impact on the sterling.

The broker believes B&M is well-equipped to negate market worries.

“Its growing international buying scale should mitigate the impact of weaker sterling on input prices and gross margins,” Canaccord said.

“With all retailers exposed to foreign exchange weakness, an inflationary environment actually serves to increase B&M's price differential and so enhance its value credentials.”

B&M has grown its business internationally with the expansion of its German retailer Jawoll, purchased in 2014.

Canaccord expects Jawoll will open about 400 stores in Germany, generating more than €1.1bn in turnover and €120m in earnings before interest, tax, depreciation and amortisation (EBITDA) at maturity based on an average sales performance and EBITDA margin.

Canaccord also sees B&M continuing to grow market share in the Value sector in the UK on the back of plans to open about 50 stores per year. The broker pointed to Verdict forecasts for growth in spending at discounters and budget retailers of 35% to £25.6bn between 2015 and 2020.

Jefferies downgraded outsourcer Capita to ‘hold’ from ‘buy’ and slashed the price target to 465p from 815p until visibility improves.

“Until visibility improves we downgrade from buy to hold and will revisit subject to working capital, bid pipeline and disposal momentum over the next three to six months.”

Last week, Capita announced that it will offload the majority of its Asset Services division and a number of other non-core businesses, and cut jobs. It also downgraded its full-year guidance for underlying pre-tax profit to “at least £515m” from a previously lowered range of £535m to £555m.

This followed a major profit warning in September.

“Balance sheet risks should subside if non-core assets are divested for £740-820m but given profit/free cash flow headwinds and narrowing headroom with the 3.5x leverage covenant, 2017 is a highly uncertain year,” Jefferies said.

The bank said second-half working capital looks weak despite lower revenue and the shrinking bid pipeline supports its scepticism that revenue growth will review.

In addition, it noted concerns about the number and public profile of underperforming contracts.

Barclays shares were under pressure on Wednesday as Exane downgraded the stock to ‘neutral’ from ‘outperform’ but raised the target price to 245p from 228p.

Exane said it had become more positive on Barclays earlier in the year due to an improved capital outlook after being “cautiously disposed” to the lender.

The issue now is that the shares trade at 0.8 times current tangible net asset value (TNAV) and Exane reckons they could struggle to progress.

“Although the TNAV multiple will be less of a focus as profits recover, it will likely provide a ceiling to valuation in the next 12 months given the lacklustre returns generated by the group," Exane analysts said.

The analysts said it is possible TNAV will come under material pressure through US litigation charges, the partial reversal of the cashflow hedge reserve, the cost of redeeming preference shares and the potential write-down of US deferred tax assets.

As a result, Exane believes TNAV could reduce by 35p by the end of 2017.

“This would overwhelm underlying earnings, driving TNAV lower and the multiple higher, perhaps to over 0.9 times,” Exane said.

“It could also drag on capital - perhaps by 130bps, slightly more than underlying capital generation.”

Exane sees adjusted earnings per share improving from 13p in 2016 to 24p in 2019, driving return on tangible equity from 5% to 8%.

Further subordinated debt opportunities would raise EPS to 26p and ROTE to 9%.

However, with limited distribution potential over the next three years, the present value of this eventual earnings stream is estimated to be 225p, in line with the 12 month target price of 245p.

Assuming investment banking revenue of £9bn in 2019, the clearing of expensive debt, an orderly disposal of the Africa business and non-core assets, a US corporate tax cut to 20% and an equity tier 1 ratio of 11-11.5% based on new rules, Exane said it sees a potential EPS of 30p and ROTE of 11% in 2019.

“Further assuming a cost of equity of 9% would value the shares at 300p in today's terms,” Exane said.

“But given the assumptions made we do not feel it is enough. In addition, many other banks would look equally attractive on this basis. After a good run, we downgrade the shares to ‘neutral’.”