Broker tips: Smiths Group, AB Foods, Loungers

Bank of America Merrill Lynch upgraded Smiths Group on Tuesday to ‘buy’ from ‘underperform’ and lifted the price target to 2,000p from 1,150p, as it pointed to "hidden value waiting to be realised".

ML noted that Smiths has more than 60% defensive and high aftermarket content assets.

"Smiths’ portfolio exposure is biased towards defensive, regulated and late cycle markets (e.g. safety & security, energy) that should appeal to investors given macro concerns," it said. "Aftermarket (AM) is circa 38% of mix and concentrated in Detection & John Crane where demand is elevated on post-pandemic aviation security upgrades & energy security/transition."

BofA ML also argued that balance sheet strength provides substantial portfolio change optionality, both organic and inorganic.

"Management have optionality to invest organically e.g. in R&D to drive product vitality and growth, or to add scale or technology through M&A, which we think Interconnect in particular would benefit from given its sub-scale positioning vs peers," the bank said.

"We see optionality to unlock significant value from broader portfolio transformation, such as we have seen elsewhere in the UK industrial space (e.g. Spectris & IMI)."

It also pointed out that the stock trades at a discount of around 25% to sector one-year forward EV/EBITA versus a slight premium historically. This discounts headwinds from construction in Flex-Tek, it said.

The bank said it was lifting its operating profit estimates by 5% to 22% on a stronger outlook for Detection & John Crane, particularly in the aftermarket segments.

Elsewhere, Shore Capital initiated coverage of Loungers at ‘buy’ with a fair value of 300p, referring to the company as a "high-quality" business.

ShoreCap said the group exhibits "exceptional and consistent" cash returns on invested capital per site of over 30% and in its view, "has the runway to replicate these returns on an estate more than double today’s size".

"We argue that: (1) the structural shift towards hybrid working, (2) evidence sites can achieve more than 30% CROIC (cash return on capital invested) in multi-site cities and towns with less than 30k population (3) significant capacity withdrawal in the hospitality sector and, the group’s hyper-localisation and refurb strategy are all supportive of high-quality site replication," it said.

"At 195p and on a 5.5 EV/EBITDA (pre-IFRS) we do not believe these qualities are reflected and in fact we believe the market has effectively priced a whole peak of trade dropping out, or in other words a robust deterioration of site returns to a level of circa 22%."

Shore said this is unrealistic given the strength of current trading, supportive secular trends and measures in place to control costs.

"At our fair value of 300p, the group would trade on a CY23F EV/EBITDA of 8.5x (pre-IFRS) and thus be more in line with operators Greggs and Tortilla which yield a similar CROIC per site of over 30% and exhibit an equally compelling growth story," it added.

Finally, RBC Capital Markets upgraded Primark owner Associated British Foods to ‘outperform’ from ‘sector perform’ and lifted the price target to 2,250p from 2,150p.

RBC said it thinks an improvement in Primark profitability should drive double-digit earnings growth for ABF, which is not being captured by the current valuation.

It noted that ABF trades at less than 13x CY24 estimated earnings per share, with over 80% of earnings coming from Primark, Twinings/Ovaltine and the ingredients business.