Broker tips: M&S, Capita, Softcat

Societe Generale downgraded Marks & Spencer to ‘hold’ from ‘buy’ and cut the price target to 424p from 545p following the retailer’s full-year results earlier in the week.

The French bank said M&S was certainly worth holding for the total dividend yield. It said the company remains strongly cash generative, backed by healthy margins and growth in the food business, with a commitment to making ongoing surplus cash returns to shareholders.

M&S announced a 4.6p special dividend for the first half and SocGen assumes a further 4.6p special dividend in the second half, along with special dividends in the outer years, in view of the company’s target net debt/EBITDA range of 1.5x-2.0x.

“The 7% total estimated dividend yield is attractive. However, we would need more than 15% total shareholder return to retain the ‘buy’ recommendation,” the bank said.

SocGen said that while M&S was lucky to have a top-end market position focusing on specialty, convenience, health and quality, Clothing and Home present an ever-increasing challenge from all angles.

“We do not expect sustainable like-for-like sales recovery at any point. It is difficult to disagree with the measures that are being taken in response to detailed customer feedback, but there is very low visibility on recovery at this stage in our view. Hence we downgrade,” it said.

The quality of Capita´s earnings is weak and both on and off-balance sheet liabilities continue to rise, analysts at Exane BNP Paribas said.

In particular, analysts George Gregory and Henry Naish took issue with the outsourcer´s accounting treatment for non-underlying software & license amortisation.

Following a meeting with the company´s finance chief, Nick Greatorex, the analysts said Greatorex´s efforts to reduce the tendency towards high accruals upon acquistion and for cutting accrued income were "encouraging".

Nonetheless, "earnings quality has remained weak and meanwhile both on and off-balance sheet liabilities have continued to rise, pointing to a concerning imbalance," Gregory and Naish said in a research note sent to clients.

So while Capita shares were trading at a discount versus peers in terms of their price-to-earnings mulltiples it was simultaneously - and with few exceptions - changing hands at a premium on the basis of its enterprise value/unlevered free cash flow.

Exane downgraded shares of Capita to 'underperform' from 'neutral' but stuck by its 1,050p target price.

Berenberg initiated coverage of Softcat, which provides IT infrastructure to corporate and public sector organisations, with a ‘buy’ rating and a 425p price target.

The bank said the business has successfully quadrupled revenues in the past five years and delivered EBIT margins materially higher than peers.

It said that with its capital-light model, Softcat should be able to deliver a return on capital employed of 60% in 2016.

“Despite a strong performance in the shares since its IPO in November 2015, we believe Softcat still has scope to grow its customer base and take market share.

“With strong cash conversion we forecast the business to grow its net cash position substantially, giving capacity for major shareholder returns.”

Berenberg highlighted “serious top-line potential” at Softcat, pointing out that the company has delivered a revenue compound annual growth rate of 33% since 2010.

The market growing at around 6% a year across the same period means Softcat outperformed the market by a factor of 5x.

With underlying market growth of 5% a year estimated between 2016-18, Berenberg has conservatively projected that Softcat will grow at 2.5x market growth, implying a top-line CAGR of 13%.