Broker tips: Direct Line, BT, Go-Ahead, AO World

The risk/reward for Direct Line is now more balanced, said JPMorgan Cazenove, as it downgraded its stance on the insurer to 'neutral' from 'overweight' and cut the price target to 430p from 450p following the company's trading statement on Wednesday.

The bank noted that Direct Line has been the best performer in the UK motor sector over the last six and 12 months and said it increasingly sees earnings upgrades as necessary for outperformance.

"Yesterday's trading statement was only negative at the margin we believe (we view the weather claims as one-off and the premium figures only slightly weaker), however, the comments on pricing/claims reinforce our view that the pricing backdrop in motor is unhelpful.

"While we continue to see the long-term attractions of Direct Line's differentiated model, balance sheet, and generous distribution policy, we believe the risk/reward has now become more balanced. For this reason, we move to a neutral rating."

Direct Line has been the bank's top pick in the sector for a number of reasons, including a strong and conservative balance sheet, a generous distribution policy and continued cost saving potential.

JPM said that while these reasons remain valid, with continued headwinds from reserve releases to come and potential pressure from a softening motor cycle, there is less urgency to deploy fresh money into the company.

BT could face increased competition for providing broadband infrastructure from wholesale-only providers, Barclays said as it reduced its rating on BT shares to ‘equal weight’.

As well as cutting BT’s rating from ‘overweight’ the Barclays analysts reduced their price target by 20% to 280p and revised down their forecasts for profit in 2019 and 2020.

There have been regular announcements about alternative providers building fibre to the home (FTTH) but so far little has been done, Barclays analysts said. But after talking to Open Fiber, which is building a fibre-optic network in Italy, the analysts believe there are opportunities for similar operations to do well in the UK.

Broadband service providers, regulators and mobile network operators would like to see the model succeed, Barclays said. As an incumbent BT finds it hard to find the right wholesale price or accelerate FTTH build. Yet BT faces a risk from alternative infrastructure providers if it does not accelerate FTTH.

The Barclays analysts said: “We see ‘wholesale-only’ providers potentially shifting the risk-reward profile for FTTH investment in Europe, principally in markets such as the UK and Germany where there is a heavy reliance on the incumbent for wholesale access, and a lack of existing FTTH infrastructure … As such, an acceleration of FTTH investment looks to us all but inevitable.”

Go-Ahead was under the cosh on Thursday as Deutsche Bank downgraded the transport operator to 'hold' from 'buy', slashing the price target to 1,840p from 2,340p in the absence of future rail franchise wins.

The bank pointed out that the shares have performed "very well" since mid-February, first on the back of good first-half results and then on read-across from Apollo's bid for FirstGroup.

"We continue to believe Go-Ahead is robust with a net cash balance sheet. However in the absence of future rail franchise wins, and with Go-Ahead's bus businesses seeing the same muted trends as the rest of the industry (London - Transport for London budget issues; Regional - anaemic volumes), it is less clear that the shares are significantly undervalued," DB said.

It added that while Go-Ahead is regularly characterised as an income stock, on DB's forecasts free cash flow, pre-working capital, in FY18E, FY19E and FY20E will not quite cover the dividend payments to ParentCo shareholders of around £44m per annum.

"It's clear that Go-Ahead has the balance sheet capacity to do this. A potential future rail franchise win would also likely lead to upwards earnings revisions and working capital inflow (albeit cash forecasts could actually move down for the initial few years on higher capex and no upstreaming of dividends from the train operating company).

"When Go-Ahead shares were substantially cheaper this was more acceptable - now it is less so."

Peel Hunt stripped shares of Bolton-based AO World of their 'buy' rating on Thursday, noting that although the group had seen continued success with its customer-focused strategy, based on where the stock was at present the time had come to downgrade to 'hold'.

Peel Hunt recognised AO World's continued market share and gross margin improvements each year in each market, despite tough macro and FX headwinds, as its investment in customer experience, operational efficiency, and supplier relationships continued to secure the firm's future.

However, the analysts' country-by-country discounted cash flow model yielded a target price of 145p and now the firm had "grown into" that valuation - which they described as 'fair'.

So with nothing having changed since that target price was set, they moved to downgrade their recommendation.

Peel Hunt predicted AO's full-year revenue would rise by 14% versus a year ago to around £796m, which would be slightly ahead of consensus, helping to bring the group's EBITDA loss in line with estimates of roughly -£5m.

Despite the downgrade, with a 58% discount to its UK eCommerce peers and its 45% equity performance since Peel Hunt initiated coverage on AO on 16 November, the analysts said they remained "strong advocates" of the firm.