Broker tips: Drax, Virgin Money and Mitchells & Butlers

Drax

JPMorgan Cazenove has moved to an ‘overweight’ rating on Drax, which was previously not rated, and rated at ‘neutral’ before that.

It said a new strategy, the acquisition of Opus Energy, and State aid approval for its biomass CfD by the European Commission put Drax on a path to a more sustainable, predictable and profitable future.

JPM said that according to its analysis, the recently-approved acquisition of Opus Energy is accretive to earnings and valuation and refreshing its estimates gives rise to earnings per share upgrades of around 30% on average from 2017.

“In particular, putting to rest the debate over Drax’s strategic direction breathes new life into a company which has borne the brunt of UK decarbonisation policy in recent years.

“Following a period of restriction, we are moving to an overweight recommendation and December 2017 price target of 420p from Not Rated (Neutral and Jun-17 price target of 370p prior to restriction), based on our expectations that the stock re-rates as the company shifts its focus from its biomass conversion programme to an integrated customer growth strategy.”

In addition, JPM said that with earnings and free cash flow on a much firmer footing, it sees diminished risk of balance sheet stress despite the increase in net debt arising from the Opus transaction.

Virgin Money

RBC Capital Markets has given the previously unrated Virgin Money an 'outperform' along with a 415p price target, as it thinks that consensus estimates are too bearish on the bank's margins, growth and cost of risk.

RBC believes that Virgin Money can take market share and outperform in the uncertain economic environment as it has low interest rate sensitivity and risk profile.

It added that Virgin Money “is a unique investment opportunity with positive characteristics of a large cap bank and a small growth stock” which it thinks will “fare well in a lower for longer uncertain economic environment”.

It said that even as the UK slows, Virgin Money’s market share gains would be able to drive growth and maintain a double digit return on tangible equity.

According to RBC's analysis Virgin Money trades at 0.9 times the 2019 estimated tangible book value and 6.9 times the price/earnings ratio.

Mitchells & Butlers

Pub group Mitchells & Butlers was under pressure after Canaccord Genuity downgraded the stock to ‘hold’ from ‘buy’ and cut the price target to 285p from 350p.

The brokerage said M&B’s reasonable return on invested capital and balance sheet strength rankings are not enough to offset poor free cash flow conversion and earnings growth scores, which result in a bottom quartile ranking on its investment screen.

“Nascent recovery could get blown away by rising headwinds; it is the most food-led of the pubcos which leaves its profit before tax and ambitious capex plans vulnerable to rising costs and competition.

“Accordingly, we move our recommendation to hold.”

Canaccord pointed out that M&B is in the first year of a plan to reduce the investment cycle to 6-7 years/pub from the current 10-12 years. It will spend £200m a year refurbishing 300 sites a year.

“The catch-up is essential to becoming competitive again. The capex should also rebalance the estate towards more premium segments with Miller & Carter (premium steak house) and Stonehouse (pizza/carvery) receiving the most capex.”