Broker tips: Centrica, Smurfitt Kappa, currencies, eurozone stocks

British Gas owner Centrica was under the cosh on Monday amid reports that the Conservative manifesto will include a cap on household energy bills, with UBS saying the snap election in June makes an energy tariff cap more likely.

The bank downgraded its stance on Centrica to 'neutral' from 'buy' and cut the price target to 215p from 255p.

"We now see implementation of some form of tariff cap as more likely than not," the bank said. It added that proposals could come this week or during the election campaign, but in either case the context of a general election increases the focus on visible action and the chance a tariff cap will be the preferred measure.

"This would be a negative development for Centrica which relies on UK retail for approx 1/3 of operating profit," it said.

UBS said a cap on the standard tariff could potentially reduce retail margins by a third.

"For now, sizing the impact requires estimation. But we note that supply margins have averaged 6-7% in recent years, mostly derived from standard tariff customers, whereas the CMA benchmark of a 1.25% EBIT margin + £15 'headroom' per fuel (used to calculate the existing prepay tariff cap) might suggest a target margin under a capped price of around 4-5%.

"If the same level were targeted on standard tariffs, it could result in a reduction of £150-200m per annum or approximately 1/3 of Centrica's UK supply margins."

To be conservative, UBS has factored in a 1/3 reduction in standard tariff margins from 2018.

However, the bank also said that if policy changes are benign, the shares could recover to 245p.

Smurfitt Kappa

Goldman Sachs recommended clients 'buy' Smurfitt Kappa on Monday, after the Irish packaging company's London-listed shares have fallen by around 7% to open an attractive entry point.

Smurfit remained Goldman's top-pick in the European paper and packaging space, as although the market has become increasingly concerned about a margin squeeze, this "is temporary in our view" as box prices are expected to increase in the second half to enable margins to recover quickly.

Smurfit trades at an 26% discount to peers on a ratio of enterprise value to adjusted operating profits (EV/EBITDA), despite offering a 10.5% free cash flow yield, which is significantly above the 5.6% average for packaging peers.

Rivals DS Smith and Mondi are both rated 'neutral' by Goldman.

"A key risk to our packaging view is increased uncertainty in Europe related to the upcoming elections. Packaging is closely linked to economic growth and could come under pressure if uncertainty increases," Goldman said.

Analysts trimmed their London target price to 2,425p from 2,500p.

Currencies: the euro and dollar

Analysts at HSBC said the French presidential election could be a positive catalyst for the euro as markets moved to price-in less political risk and greater economic upside in the eurozone, but increased political uncertainty in the US would be negative for the dollar.

Centrist Emmanuel Macron winning the first round of voting in the French Presidential election on Sunday and likely being crowned the next president could be a turning point for the euro with political risk fading, while high expectations about the US administration’s fiscal agenda could lead to disappointment.

Market participants are likely to spend the second half of 2017 focusing on when the European Central Bank will abandon its quantitative easing measures, while the prospect of a gradual tightening by the US Federal Reserve is already priced in.

The cyclical upside of possible US fiscal stimulus may turn to structural concerns over the fiscal deficit, which would turn the dollar implications of tax reform from positive to negative.

HSBC also said that the emphasis on bilateral trade imbalances and on a weaker dollar will give prominence to the so-called 'twin deficits' between shortfalls in government spending and foreign trade.

The bank said that the US wants a weaker dollar as US president Donald Trump has repeatedly said that the greenback is too strong.

Against this backdrop, the bank has upped its year-end 2017 forecasts for both euro/dollar and sterling/dollar forecasts to 1.20 from 1.10.

It also lowered the year-end dollar/yen forecast from 110 to 100 reflecting both dollar weakness and a renewed recognition that 'Abenomics' is not working in Japan.

Meanwhile, the dollar/yuan forecast was trimmed to 7.10 from 7.20, with structural outflow pressures expected to lead to a steady weakening in the Chinese currency.

Eurozone stocks

Emmanuel Macron's win at the weekend could spark an up to 10% re-rating in eurozone equities in comparison to US stocks, strategists at JP Morgan said.

With polls ahead of the second round of voting in the country's presidential elections assigning Macron a 20 point lead over his rival Marine Le Pen, "the hurdle rate for a surprise is too big now", they said.

That should see 'risk-on' trades being put back on, with yields on German government bonds and the spread between them and those from periphery euro area countries narrowing, which is "very positive" for banks.

Corporate earnings are delivering too, with upwards revisions in the euro area printing their best levels of the upcycle so far, with cyclicals doing best, JP Morgan said.

Unlike at the same time of the year in 2016, analysts' forecasts for companies earnings per share in 2017 are heading higher, with those for cyclicals - especially materials, discretionary and industrials - up by 5% year-to-date.

For defensives on the other hand they are 0.5% lower.

Reflecting that, euro area stocks have seen fund inflows worth between 1% to 3% of assets under management, in stark contrast to the 15% of AuM in outflows witnessed at the worst point in 2016.

"If one were to see the reversal in the outflows, we project that this could drive a 10% relative re-rating in the price-to-earnings multiples of eurozone equities versus the US."

Banks and stocks from the periphery have the most upside, with Spain being JP Morgan's top-pick, although Italy "should catch up too".

Cyclicals should continue leading defensives - as they have over the past two months - in order to close the gap in terms of their relative earnings, the strategists said.

So what's the proper strategy at present? "Buy the dips".