Broker tips: Direct Line, Dunelm, Aggreko

Barclays downgraded Direct Line Insurance to ‘equalweight’ from ‘overweight’ and cut the price target to 369p from 443p as it took a look at UK motor insurers.

The bank noted Direct Line has been one of the best performing insurance stocks since its IPO in 2012, more than doubling from its 170p IPO price and returning two-thirds of the price as dividends.

“However, we believe the stock is now fairly valued as we lower our estimates for the loss of its Nationwide and Sainsbury’s contracts.”

The bank said it expects more special dividend from Solvency 2 in 2016, but thereafter, it estimates dividends will be around 80% payout of earnings, offering a yield of approximately 6%.

“Although we believe Direct Line will benefit from the pricing cycle, we believe Direct Line is most at risk from reduced reserve releases.”

Overall, Barclays said it was positive on the UK motor market, as it reckons this is the first major property and casualty market to inflect and harden.

“We believe DLG as the largest player in the market is poised to benefit,” it said.

Canaccord Genuity kept Dunelm at a ‘hold’ rating but raised its target price to 950p from 910p, saying it has “long traded at a significant premium to the wider sector”.

The home furnishing retailer on 7 April reported third quarter revenue growth of 5.9%. Total like-for-like (LFL) growth, combining LFL stores and home delivery, increased by 1.1%.

The company pointed out that, due to the 53rd week included in its last financial year, the period included six days fewer winter sale days year-on-year, reducing like-for-like growth by 4.9% or £1m in the third quarter, though that was partially offset by the earlier Easter contributing 1% towards performance.

Adjusting for the calendar impacts, underlying like-for-like performance was "a very pleasing" 5% for the 13 weeks to 2 April, the broker said.

“The 28% increase in Home Delivery remains an important contributor to total LFL sales growth, but our estimate of underlying 3% Store only LFL sales growth shows that the focus on this specific area, re-initiated by (founder) Will Adderley, continues to bear fruit,” said Canaccord analyst David Jeary.

“The 90 basis points (bps) gross margin improvement in the third quarter was also stronger than we had expected, even though our full-year assumption of a 50bps gross margin improvement is in line with the guidance given by management in the Q3 update.”

Canaccord raised its full year 2016 forecasts by £1.5m (+1.2%) to £128.5m. Jeary said the change to profit estimates broadly reflects a £4m increase in the sales forecast.

“Given its characteristics as an organic growth stock, along with relentlessly strong cash generation and special distributions, Dunelm has long traded at a significant premium to the wider sector,” he said.

“This premium has been as high as 40% over extended periods, but in recent times has more typically been trading around a +/- 20% premium. On the basis of the delivered LFL performance in Q3 and our small upgrades, we have increased the premium we apply to the wider sector from 15% to 25%. This drives a new target price of 950p (from 910p).”

Canaccord retained its hold rating due to the sector de-rating over the past quarter.

Temporary power provider Aggreko was under the cosh after UBS downgraded the stock to ‘sell’ from ‘neutral’ and slashed the price target to 800p from 1,050p.

“Weak markets have undoubtedly been a headwind for Aggreko for the past 3 years, but we now believe that Aggreko's problems are structural too,” the bank said.

As the power rental market has matured, Aggreko's competitive advantage has been eroded, UBS said.

As a result, it expects pricing to come under increasing pressure, eating through cost savings and further compressing return on invested capital.

“A new product line is likely necessary to reinvent Aggreko, but we wouldn't expect to see a material benefit until 2020+m,” it said, adding that it expects to see continued earnings risk and for the valuation to remain constrained.

UBS said Aggreko urgently needs to launch a new product before it can hope to rebuild a unique competitive advantage and hit targets for return on capital employed.