Broker tips: Tullow Oil, Sainsbury's, Shire

Jefferies downgraded Tullow Oil to ‘underperform’ from ‘hold’ with an unchanged price target of 166p.

The bank said it was increasingly concerned over operational issues at the Jubilee field, which is a fundamental stock risk overriding opportunity from oil shows in a new Kenya basin.

“Now trading 36% above our unchanged PT and at $22/boe 2P reserves the market is once again pricing in an unwarranted premium,” it said.

“Our upgrade to ‘hold’ in September 2015 accepted TLW trading at $19/boe 2P & $35/boe 1P reserves, both significant premiums to M&A precedent. Six months on, we see zero industry appetite for such premiums.”

Jefferies said it continues to expect banks to be supportive to Tullow debt facilities and also expects the TEN development on stream as planned during the third quarter of this year.

However, it also continues to expect lower plateau rates from that field versus expectations.

Also on Monday, Jefferies upgraded Soco International to ‘buy’ from ‘hold’ and lifted the price target to 180p from 127p.

It said Soco's dividend continues and is likely to grow with a special in the second half of the year.

It said the 2p per share dividend was already ahead of its expectations, and with a flagged special dividend in the second half, Jefferies forecasts a total payout of 6p per share for 2016.

“Soco, alone amongst peers, prioritised cash returns over M&A during ‘high’ oil price. In a ‘low’ oil price cycle, returns continue but (value accretive) M&A can return.”

Sainsbury's has not entirely won over analysts despite being allowed an unchallenged path to the takeover of Argos owner Home Retail on Friday, with several remaining neutral and Goldman Sachs maintaining a 'sell' rating.

After Steinhoff International unexpectedly withdrew its rival bid on Friday afternoon, Sainsbury's announced a cash and share offer one minute after market's closed for the week.

The offer was the same as that made on 2 February, thought the value of the deal has risen to 173.2p for each HRG share thanks to the appreciation of the grocer's own share price in the interim.

For each of their shares, HRG shareholders will be entitled to receive one 0.321 new Sainsbury's shares and 55p in cash, as well as a 27.8p-per-share special dividend of HRG's cash mostly from its recent sale of Homebase.

Having crunched the numbers again, Sainsbury's also said it now expects EBITDA synergies of not less than £160m in the third full year after completion, £40m more than its previous estimate.

The supermarket group and the trustee of the Home pension scheme have reached agreements with regards to the future funding of the Home pension scheme, if the deal completes.

Under this agreement, Argos would pay an additional £40m yearly sum in deficit contributions and a £50m lump sum following completion.

The bid for HRG has not earned board approval from the target just yet albeit with Steinhoff out of the way, Shore Capital analysts said "this may prove not to be tremendously challenging for Sainsbury's to receive".

The Argos board published a release after market close stating that it "looks forward to working with Sainsbury’s towards a recommendation of the offer", which would see HRG shareholders own circa 12% of Sainsbury's equity.

ShoreCap said it was "warmer than cooler" but needed firmer numbers before putting out a more definitive recommendation, based upon forecasts for the medium-term to allow us to move beyond its present 'hold' stance.

Although it did not take a view on the likelihood of the proposed deal taking place, Goldman Sachssaid its 'scenario analysis' suggested the deal would be reap an extra 18-30% earnings per share in year-three post deal at an achieved synergy range of £120-160m and depending on whether additional pension contributions are considered earnings dilutive.

Goldman retained its 12-month target price of 185p on Sainsbury's stock, based on a discounted cash flow with an 8% discount rate and 1% terminal growth.

Nomura has already attributed £120m of synergies within its 280p Sainbury's target price, anticipating £90m from occupancy, £60m from one-quarter of Argos rents being relocated but sales if anything gaining, £25m from central costs, and just £5m from Tu and from joint buying.

"We do not move to add the extra £40m, but note that if we did, it would add £360m - 15p per SBRY share - to our target price," Nomura added.

Pharmaceuticals group Shire was the standout gainer on the FTSE 100 on Monday as Exane BNP Paribas said the stock looked too cheap.

The bank said it was selling its position in Swiss pharma company Roche and switching into Shire.

“Shire, on a forward P/E of just 12 for top line growth of 14% this year and EPS growth of 20% just looks too cheap,” Exane said.

It said much of the cheapness was due to some disillusion with Shire’s pursuit of Baxalta, which many investors see as diluting the company’s long-term growth path and others see simply as a move to shift Shire’s market capitalisation out of the M&A target zone.

“The transaction, around 2/3rds in shares, has also created a significant flow of risk-arbitrage short selling which has depressed the share price,” Exane said.

Exane said that whatever management’s reasoning is behind the deal, “it doesn’t look such a bad long term move to us” and certainly not bad enough to justify a price/earnings to growth ratio of 0.6x.

It noted that by comparison, Roche – which has EPS growth forecast at 6% and a P/E of 17.5x – sports a PEG ratio of almost 3.

Shire announced in January that it had agreed a $32bn takeover of US-based Baxalta after a six-month pursuit.

The stock fell sharply in the wake of the deal announcement and is down around 15% year-to-date.

When Exane upgraded Shire to ‘outperform’ back

in January, it said the stock’s valuation was compelling whether you liked the fundamentals of the deal or not.

It said in its note at the time:”We downgraded the stock following the first Baxalta bid on the basis that we were entering a prolonged period of uncertainty over price and timing.

“Over the subsequent five months Shire's share price fell approximately 25%. Now we have clarity on the Baxalta deal and whilst it may not have been the best M&A opportunity in our view, it is nonetheless a value-enhancing deal.”