Broker tips: TalkTalk, Ultra Electronics, Halma, GKN

TalkTalk fell on Friday as RBC Capital Markets cut the stock to ‘sector perform’ from ‘outperform’ and reduced the price target to 125p from 140p.

While TalkTalk has performed well since its equity placing, the bank is concerned that BT is about to reboot its consumer strategy with a primary focus on convergence.

"Having stepped back from a converged strategy using a mobile virtual network operator, we think TalkTalk is relatively defenceless against any aggressive BT bundling, which could lead to heavy subscriber losses," RBC said.

The bank also highlighted pricing issues, saying that although TalkTalk remains value-oriented it is not the cheapest, with Vodafone undercutting it in both slow and fast fibre.

"We believe TalkTalk needs to demonstrate continued growth in its core residential subscriber business. Average revenue per user needs to stabilise, following recent weakness (wholesale dilution/mix effect) and the impact of resetting (down) subscriber prices.

"Potential risks for TalkTalk include an increase in competitive intensity at the low end of the UK market through either new entrants or existing players replicating TalkTalk offers at lower price points."

Berenberg upped Ultra Electronics to ‘hold’ from ‘sell’ on Friday, lifting the price target to 1,440p from 1,300p.

It said Ultra has weathered a difficult few months following the profit warning last November, the departure of the chief executive and termination of the planned acquisition of US-based Sparton.

However, the market has now digested these developments and priced in Ultra’s inherent risks, as evidenced by the selloff of around 25% in the share price since October, Berenberg argued.

"In our view, the sell case has largely played out, and based on improving fundamentals we now view downside risk as limited."

Berenberg said it’s increasingly confident that expectations have been reset to a realistic level, which in its forecasts translates to 1% organic growth and trough earnings in 2018. Thereafter, it expects low organic growth, supported by recent order activity, current programme positions and an improved budget outlook in the core US defence market, with the earnings profile enhanced by a £134m buyback.

The risks that remain include UK defence budget uncertainty, a US Department of Justice sonobuoy antitrust review and ongoing litigation relating to the cancelled Oman IT services contract.

"We expect the shares to tread water until we receive certainty (either positive or negative) on these risks, with a potential update at the Q1 trading statement (date TBC)," Berenberg said.

Separately, analysts at Berenberg initiated coverage on manufacturer Halma on Friday, calling it one of the "highest-quality companies in the UK industrials sector" and placing a 'buy' rating on the firm's shares straight off the bat.

The German broker said that with its high market shares in niche segments of industries, combined with its strong diversification by geography and end-market, Halma had displayed "impressive organic growth", and felt the company still held the potential to grow significantly in both developed and emerging economies, as well as into adjacent and new market verticals, over the coming years.

On the flip-side, Halma, which operates in typically slow-moving industries, could be disrupted by the current trend towards automation and data exchange in manufacturing technologies, the so-called "fourth industrial revolution", it said.

Also according to the broker, the winners in this particular race would be the companies that were well-aligned with connectivity trends, were partnered with technology firms, had capacity to invest, and had scale within a nimble operational structure.

"As we believe that Halma exhibits all of these characteristics, we think it is as well-positioned as any to succeed and take market share over the medium-term," the analysts said.

Given the increasing size of the business, Berenberg also noted that to sustain its impressive 13% EPS CAGR, Halma will need to execute larger and more frequent deals in order to maintain its premium market rating.

Yet after having assessed the company's track record, financial capacity and scale of M&A opportunities, it believed this was "comfortably achievable" over the medium-term.

"Quality does come at a price (24.7x 2019E P/E, 17.7x EV/EBITDA), but we expect this growth trajectory to be sustained over the medium term and believe the recent pullback in the shares (-6.5% YTD) provides an attractive entry point for investors. We initiate coverage with a Buy rating and a GBp1410 price target."

Melrose Industries, which recently won its battle to take over engineer GKN, got a boost on Friday as Goldman Sachs added the buy-rated stock to its Conviction List.

Goldman said the stock is "fundamentally undervalued" and that its share price materially underestimates potential future value creation.

"On our analysis, we highlight that GKN could be circa 40-60% earnings accretive to Melrose under a range of GKN margin scenarios by 2020," the bank said, as it reiterated its 12m sum-of-the-parts price target of 320p, which remains premised on 120p value creation from inorganic growth opportunities in addition to a 200p valuation for Melrose’s existing assets.

Acquisitions aside, Goldman also sees scope for potential value creation from the disposal of some or all of Nortek in 2018, as previously flagged by Melrose management.

As far as risks are concerned, GS said there is still some risk the GKN deal might be blocked. "Despite UK defence revenues only equating to circa 1% of GKN’s revenues, the debate has been well publicised and UK government intervention remains a risk, although not our base case. The deal is also waiting CFIUS (US) clearance," it said.

In addition, it pointed out that the company’s high US exposure means it would be negatively affected by a depreciation of the US dollar versus the pound. However, earnings would benefit from depreciation in the yuan versus the pound.