Broker tips: Drax, ASOS, Centrica

Analysts at RBC sounded an upbeat note on Drax, telling clients the electricity generator's shares continued to offer a "compelling" investment case despite the recent rally in their share price.

On the basis of its current assets, the Canadian broker said there was scope for shareholder returns from dividends and buy-backs to exceed the company's market value within six to seven years.

Another possibility was that should all of Drax's planned growth options "materialise", that would cut shareholder returns, but under a 'blue-sky' scenario that would result in a "significant" valuation uplift, with potential for more than 60% capital upside.

Nevertheless, the broker did not anticipate the firm would push forward with longer-term growth options in the UK generation market.

As a result, with free cash flow yields of between 15% to 20% from 2019 onwards, even after taking into account all its capital expenditures, the analysts believed the company would be able to return approximately £1.4bn between 2018 and 2025 - exceeding the firm's current market value.

Then there was the chance that Drax would pursue and deliver on all its growth options, including building 1.2GW of open cycle gas turbines and conversion of two coal units to 3.6GW of CCGT capacity, adding 20p and 30p per share to the valuation, respectively, and resulting in a blue-sky valuation of 460p per share.

Overall, RBC reiterated its 'outperform' recommendation, setting a 370p target in the process.

Interim results from ASOS lend further support to broker Canaccord Genuity's thesis that the cost of the retailer's growth will continue to come in ahead of market expectations, "making its valuation hard to justify".

ASOS reported a first-half pre-tax profit of £29.9m that was a "small" miss versus City expectation on sales growth of 27% was slightly below consensus expectations of 29% and a US performance a "little weaker" than expected.

The e-retailer's showing remained strong throughout its first-half trading, pushing gross its margin up 100 base points, in line with expectations.

As expected, operating costs grew ahead of sales, with warehousing costs the main drag factor as various distribution centres ramp up, but Canaccord pointed out that while ASOS' other costs appeared to have been well dealt with, despite the gross margin increase, its EBIT margin fell by 40bp to 2.6%, also in line with general consensus.

Canaccord reiterated its 'sell' rating on ASOS, along with its price target of 3,622p.

"We have been consistent sellers of ASOS with a thesis that the cost of growth will continue to come in ahead of market expectations making the valuation hard to justify - today lends further support to our thesis," the broker said.

Analysts acknowledged that the miss versus H1 expectations is small, but in the context of materially raised cash costs, no change to profit guidance and shares trading for 66.7 times full-year EPS, the shares were expected to react negatively.

HSBC's analysts downgraded multinational utility company Centrica to 'reduce' on Wednesday, saying that while its recently announced price increase would help maintain its margins, it may, in turn, precipitate further customer losses.

For the shares to rerate, HSBC believed that Centrica had to stop losing customers as the firm had been squeezed by intense competition in both its conventional supply business from players such as Engie and Shell and in its Connected Home business from Amazon and Google

HSBC said that while Centrica may well have the cash to pay its dividend in 2018, something it has been aiming to commit to at 12p for the year, its analysts believed that the market would need to see a return to customer growth in home energy as well as progress towards profitability in its connected homes and distributed energy divisions first.

"We cut our 2018e EPS by 8% and 2019e by 17%, including an increase in the SVT cap EBIT impact of £140m from £75m, previously. We assume a 25% dividend cut for 2019," HSBC stated.

In addition to the downgrade, the analysts also cut their target price on Centrica from 150p to 120p.