Broker tips: Tesco, Mitchells & Butlers, CRH

Calculating that Tesco's sales performance at larger stores is likely to be worse than reported and that margins should be "permanently rebased lower", Credit Suisse has cut its earnings estimates and its target price on the supermarket group.

Credit Suisse cut its TP to 115p from 135p but kept its 'underperform' rating.

Analysis by the Swiss bank has indicated that its Tesco's larger stores, which represent not far off half its UK grocery space, generated like-for-like sales 2.3% lower in the 2016 financial year, with the cumbersome 'big box' stores create a "structural EBIT headwind" of -1.7%.

Tesco's real estate burden "appears unique and intractable" as efforts to buy back leases and other property deals eases off after the £1.7bn made so far, while real estate flexibility is further limited by £3.6bn of structured debt transactions over 106 stores that average around 70,000 sq ft.

Further deep scrutiny of the supermarket group by analysts reveals "no obvious path back to historical margin levels - or what 'normal' margins should be".

As a result, the UK terminal margin is cut to 2.2% from 2.8%, which in itself assumes Tesco can mitigate 50% of the structural drag of its large stores.

After cutting UK and Ireland EBIT estimates by 14% and 29% for 2018 and 2019 respectively, group operating profit estimates respectively fall by 8% and 17.8%, which leads to the reduced target price based on a discounted cashflow model.

Shares in Mitchells & Butlers gained on Wednesday after HSBC upgraded the stock to ‘buy’ from ‘hold’ and raised the target price to 340p from 300p.

HSBC said while the company’s first half results showed weak trading trends, the new chief executive Phil Urban has a “credible plan for improvement”.

Mitchells & Butlers, which owns Harvester, All Bar One and Toby Carvery, reported a 1.5% fall in revenue to £1.1bn although pre-tax profits climbed to £83m from £75m.

CEO Urban announced plans to reduce stores at its Harvester chain to address fierce competition and real wage inflation following the introduction of the National Living Wage.

The group has also boosted investment in the refurbishment of sites to make them more attractive to customers. It follows a review which showed revamped outlets had done better than un-refurbished sites.

“We think that this is the right approach. As we show in this note, M&B has repeatedly underinvested in its sites, so it’s hardly surprising that customers have gone elsewhere,” HSBC analysts said in a note.

“We calculate the capital expenditure (capex) shortfall could be around £140m over the last five years. The new strategy addresses this; a £20m step up in capex per annum, along with a reduction in new site openings releases much more to be spent on refreshing the existing estate and converting underperforming sites into different brands.”

HSBC said the shares have underperformed compared to its peers, trading on a fully adjusted enterprise value/earnings before interest and tax (EV/EBIT) discount of 12% to the wider sector.

The bank added that its sees value in the shares. “If sales begin to recover, as expected, and earnings forecasts stabilise, then the valuation should move back towards the wider sector.”

CRH was well-placed to benefit from recently passed legislation Stateside to boost spending on infrastructure, analysts at JP Morgan said.

Based just on guidance from US aggregates companies there was 7% upside to then current estimates for the company's earning per share in 2016, Elodie Rall, Rajesh patki, Emily Biddulph and David Min said in a research note sent to clients.

The outlook for construction activity in the States was robust, the analysts said, underpinned as it was by structural undersupply in the housing market and the recent approval by the federal government of funding for highways, the so-called 'Fast Act'.

Fast was expected to result in higher federal spending in 2016-2020 and provide states with the confidence necessary to undertake the necessary planning for long-term infrastrucrture projects.

That would give the Dublin-based company´s America´s Materials´ Division - which generated about 55% of its earnings before interest, taxes, depreciation and amortisation - a shot in the arm, the broker said.

Fatter margins wre also likely at its asphalt arm, given bitumen costs had dropped further.

The shares valuation was attractive, ther broker said, as they were changing hands at only 8.3 times their estimate for the firm´s 2017 EBITDA, versus the average 15% premium at which they had traded over the past three years.

Higher consensus earnings estimates and falling leverage should see that gap close, JP Morgan added.

"Our revised EV/EBITDA-based PT of €30 to May-17 suggests 12% upside, although we note that an SOTP valuation would lift our PT to €33, 23% upside potential."