Broker tips: GKN, Smith & Nephew, Europe banks

HSBC initiated its rating on GKN at ‘buy’ with a target price of 395p on Thursday, saying it believes the automotive and aerospace engineer is a “well-managed, technology-led, high market share business”.

The bank said GKN has a clear strategy focused on sustainable growth. The delivery of shareholder value is bearing fruit with new technology and the possibility of further acquisitions providing potential for enhanced earnings, HSBC added.

“We believe that GKN has strong brand recognition in its chosen markets.

“For example, 90% of the world’s automotive manufacturers partner with GKN and it supplies passenger cabin windows for all of Boeing and many of Airbus aircraft.”

HSBC sees the main drivers of future growth as: demographics – globalisation, rising population, urbanisation and ageing; environmental – fuel efficiency, electrification and automation; and technology – additive and digital manufacturing.

The bank said GKN has world-leading technology, is an important supplier to major original equipment manufacturers in its core end markets and has exposure to structural growth drivers.

“This is compounded with the potential for the group to expand margins, improve earnings quality and thus enhance valuation multiples,” HSBC said.

“We accept that the group’s lower-than-sector margins and large pension liability are a cause for GKN’s valuation discount, but even when adjusting for these, the stock still looks cheap.”

HSBC expects the third quarter trading update on 25 October to be in line with forecasts and to highlight a continuation of the positive trends seen in the first half of 2016.

Smith & Nephew’s shares fell on Thursday as Berenberg downgraded the stock to ‘hold’ from ‘buy’ and cut the target price to 13.40p from 14.85p.

“Smith & Nephew has gradually de-emphasised its slower growth areas and implemented various cost-savings measures, reinvesting the proceeds in faster growth areas of the business,” according to Berenberg.

“However, the success of this strategy has been largely offset by various missteps and one-off headwinds, a trend we expect to continue.”

Berenberg said it has become more cautious about the medical equipment manufacturing company’s organic revenue growth.

While the broker expects earnings growth to accelerate to 12% in 2017, three percentage points of it is dependent on a yet-to-be announced buyback, which is far from certain.

“Hence we no longer expect a large enough inflection in earnings growth of sufficient quality to drive the stock higher and reduce our rating to ‘hold’.”

Berenberg added that it believes Chinese destocking, a slowdown in oil states, share losses in Wound Care and a weak hip business are all hampering growth.

“Other parts of the business, such as Knees and Sports Medicine Joint Repair, are continuing to trend well, in our view, but when more than 40% of sales are either declining or virtually stagnating, as we expect to be the case in Q3 2016, it is hard for the group to deliver the mid-single-digit revenue growth that we think is needed to: a) drive operating leverage; and b) satisfy shareholders.”

Berenberg said it thinks revenue growth and the pace of margin expansion are likely to fall short of investor expectations in the next 12 to 18 months.

The broker said an eventual emergence of a bid for the company seems likely but it has now been 48 years since the idea was first appreciated when Unilever tried to acquire the firm so it might be “a long time coming”.

It's been a turbulent couple of weeks for the banking sector as investors worried Deutsche Bank wouldn’t be able to cough up its $14bn fine to the US Department of Justice, but Citigroup provided some cheer for the sector by upgrading European banks to ‘overweight’ from ‘neutral’.

In its latest equity strategy note, Citi pointed out that eurozone banks are the worst performing region/sector of the 285 it tracks in the last 10 years, making them the world’s “biggest contrarian position”.

Citi said that while it acknowledges fundamental headwinds such as low interest rates and regulatory risks, there are also signs of improvement such as the credit cycle, loan growth and improving returns.

“European banks are back to 2008-09 and 2011-12 levels on several valuation metrics, i.e. previous levels of system risk. European banks have never traded this cheap relative to US banks, the gap between European bank credit and equity is at system risk wides and banks have been sharply de-rated in the last year on a DY relative basis.

“The sector is better priced for disappointments and not priced for reducing risks, in our view.”

However, Citi wasn’t bullish across the board, as it remained cautious on UK domestic banks.

The bank downgraded telecoms to ‘neutral’ to fund the move on banks, but said it continues to prefer telecoms to utilities.

Citi has buy ratings on BBVA, Standard Chartered,Danske, KBC, Intesa, BNP and ING.