Broker tips: BP, Smiths, Imperial Brands

Morgan Stanley downgraded its view on shares of BP by one notch from 'overweight' to 'equalweight', predicting that management would continue to prioritise debt reduction over the dividend payout.

Even so, as confidence grew in its payout, Morgan Stanley expected the shares' dividend yield to fall.

Worth noting, the broker also revised its target prices for multiple stocks in the energy sector lower, with BP's falling from 645p to 550p, Total's from €56.0 to €55.6 and Shell's from 3,040p to 2,830p.

The target price cut on Shell was despite the broker's forecasts calling for it to be the next to raise its dividend, with its free cash flow reaching $21bn in 2018 on an oil price of $64 a barrel, rising to $24bn in 2020 at $60 oil, resulting in FCF dividend covers of about 135% and 155% in each of those years.

"If history is any guide, BP's financial outlook is strong enough so that investors do not demand a yield much bigger than ~5.2% [from 6.2% at present], which is our target yield by end-2018. This still suggests a return prospect of ~23% – healthy but less strong that its two direct peers (Total and Shell)."

Imperial Brands was under the cosh on Tuesday as Piper Jaffray cut the stock to 'neutral' from 'overweight' and reduced the price target to 2,800p from 3,500p, highlighting a cheap valuation but a modest earnings per share growth outlook.

The US investment bank said it expects further reinvestment spending to weigh on EPS growth as the company expands in vapour and considers a heated tobacco launch.

"The stock trades at just 10x our 2019E calendar EPS, but this looks less attractive relative to modest EPS growth (we estimate 1% 3-year growth), especially without a proven heated tobacco platform (which we consider a much bigger opportunity than vapour, Imperial's focus to date)."

Piper Jaffray cut its FY18 EPS estimate to 260.5p from 265.7p and its FY19 forecast to 266p from 294p.

It said that while Imperial hasn’t actually committed to a heated tobacco launch, there is a risk to FY19 EPS growth from likely launch investments, as rival Philip Morris's momentum with electronic tobacco device IQOS makes it too difficult to rely on vapour products alone.

Barclays initiated coverage of diversified engineer Smiths Group at 'overweight', with a 1,800p price target as it highlighted material change under the current management team.

"Since Andy Reynolds Smith took over as CEO in 2015 we have seen a return to active management of the portfolio, an operational improvement seen through much-improved cash dynamics and a much greater focus on organic growth," it said.

Barclays noted that cash flow has seen a material, positive change as the benefits of the focus on working capital, operational improvements and a reduction in pension contributions impact the business. In addition, it said Smiths has had clear improvement in free cash flow since the FY14 trough and now has a higher free cash flow margin than its peers for the first time since FY10.

"We see this as evidence that changes brought to the business post-Andy Reynolds Smith becoming CEO are having an impact and Smiths Group is changing."

Barclays also argued that pension risks are diminishing, with the company reporting an accounting surplus for each of the last two fiscal years, while cash contributions are falling and the estimated buyout value for the three main schemes has fallen to around £1bn, or 2.2x FY17 free cash flow.

"This is less than 20% of Smiths’ market cap and so we feel the pension is much less of an impediment to changes, and cash flow, at Smiths than in the past."