Broker tips: De La Rue, Prudential, Royal Mail

De La Rue’s shares fell on Wednesday after Numis cut its rating on the stock to ‘hold’ from ‘add but raised its target price to 580p from 563p.

The banknote printer last week reported its full year financial statement, which included two sets of results before and after the disposal of the Cash Processing Solutions (CPS) business on 22 May.

De La Rue had announced it sold CPS to Privet Capital for £3.6m the day before the full year results were published on Tuesday.

Before the disposal underlying pre-tax profit for the year to 26 March 2016 fell 13% to £50.5m and underlying operating profit dropped 10% to £62.5m due to the loss of £7.9m in CPS. Revenues rose 3% to £488.2m

On a continuing operations basis, group revenue was up 7% to £454.5m, underlying operating profit increased by 2% to £70.4m and underlying profit before tax was up 2% to £58.5m.

Chief executive Martin Sutherland said the company had made good progress on its five-year strategic plan to transform into the business into a technology-led security product and service product.

“We have reorganised the business structure, increased investment in product development and new technologies, and successfully completed a manufacturing footprint review,” he said.

The manufacturing footprint review concluded that the company could achieve more than £13m of annual savings from fiscal year 2018-19 by reducing the number of print lines and consolidating banknote production into four centres. The group said it will reduce banknote print production capacity from eight billion to six billion notes a year, matching current and long term average market demand.

“Some rare good news here of late with the favourable 13 April update and the CEO delivering in terms of his promise if necessary to sell/close CPS,” said Numis analyst Charles Pick.

“We also like the good start to the new strategy execution. However, there are negatives too: pre-tax profit could be -16.9% this full year before rebounding as cost savings from the manufacturing footprint review mount.”

Pick said reasons for caution in this current fiscal year include: the boost to last year’s fourth quarter results from atypically long production runs for banknotes with low wastage rates; the high margin security features contract that ended last December; and the possibility that earnings before interest and tax at Identity Solutions could be lower year-on-year.

“It is also probable that net debt will now trend higher, given extra capex and other costs for the manufacturing footprint review. This said, the CEO is a man with a definite plan and a strategy that looks likely to revitalise De La Rue, whilst by full year 2018/19 pre-tax profit ought to considerably surpass the 2015/16 outturn and upgraded free cash flow should enable some pay down then of net debt.”

Societe Generale has downgraded Prudential to a 'hold' rating from its previous 'buy' due to pressure on the investment and savings group's earnings from tougher conditions in Asia and the US.

Cutting its 12-month price target to 1,400p from 1,900p, SocGen said Pru's US franchise is under increasing pressure in its annuity market.

Firstly, as most of its variable annuity (VA) products carry equity return guarantees of around 5-6%, these are being uncovered by weak equity markets.

Giving an example of the growing risk, SocGen noted that the net amount at risk (NAR) for these products reported in SEC returns tripled to £8.6bn in 2015 - 75% of tangible book value - from £2.6bn in 2014.

"This isn't an immediate threat to earnings or solvency since only some 7% of these guarantees can be cashed in annually, but if US equities continue to underperform, this could quickly become a serious challenge."

Furthermore, sales across the whole VA market are expected to come under pressure from the Department of Labor's (DOL) Fiduciary Rule, which changes how financial advisers can counsel clients on retirement assets.

In Asia, SocGen expects Pru's booming sales in Hong Kong to slow as the inflows from mainland Chinese moderate.

"Given the dull sales growth currently being experienced in Prus other key Asian territories, this means that there is likely to be a significant overall slowdown in Asian growth."

As a result analysts cut their IFRS earnings growth forecasts by 3% to 118p in 2016, by 8% to 126p in 2017, and by 12% to 134p in 2018, reducing growth to single-digits over the next five years.

"We regard this as optimistic and emphasise that earnings risks remain to the downside if US equity markets underperform."

Analysts at Credit Suisse hiked their target price on shares of Royal Mail based on their expectation that the firm´s management would be successful in finding the necessary efficiency gains to keep earnings flat.

In a research report dated 31 May, analysts Neil Glynn and Julia Pennington also referenced Royal Mail´s strong finish to its last financial year and how the company appeared increasingly comfortable with the competitive landscape in the market for parcels delivery.

On the basis of the above, they now estimated earnings before interest and taxes (before transformation costs) would reach in between £729m and £748m over the three fiscal years to the end of 2019.

However, whereas the analysts judged that financial markets were now more comfortable with the shares´ 14.5% outperformance versus the Footsie in the last three months, they added they were “wary of potential M&A expectations building”.

It would be difficult for a tie-up with PostNL to deliver value and the ownership structures at key competitors were a hurdle to possible transactions (DPD owned by La Poste, Hermes by otto group, Yodel 5%-owned by Amazon, and TNT owned by Fedex), Glynn and Pennington said.

Further parcel consolidation, on the other hand, especially in the fragmented UK market, would be helpful, they added.

Credit Suisse raised its target price on the shares by 11% to 559p, representing a 30% discount to DP DHL in terms of their relative EV/EBITDA multiples (enterprise value-to-earnings before interest, taxed, depreciation and amortisation).

Nevertheless, Royal Mail´s three-year average free cash flow yield was a less attractive 5.4% as a result of the cash requirements that restructuring efforts would entail, the broker said.

Credit Suisse kept its recommendation at ‘neutral’.