Broker tips: ARM, Tate & Lyle, Inchcape

After another strong set of quarterly results, ARM remains the top pick as Numis believes the recent investments should be taken as a sign of confidence that historic growth rates can be sustained as ARM deepens its value add in existing markets and continues to address new markets.

"The analyst meeting indicated confidence in further growth in mobile despite slower growth in smartphone volumes, with growth coming from higher royalties with increased performance as with v8, multiple cores and additional IP," the broker said, with strong prospects in enterprise infrastructure and 'embedded intelligence'.

The stock trades at a p/e of 28.8x, below the bottom of the 30-55x historic range, whereas prospects to sustain earnings growth at least in the high teens "continue to remain very strong".

Virgin Money was added to the list on the view that it will continue to benefit from both strong earnings growth and improving return on tangible equity (ROTE) while markets remain favourable and mainstream competition is "distracted/restricted".

"Furthermore, improved utilisation of the operating infrastructure acquired from Northern Rock should, in our view, underpin significant balance sheet growth for very little incremental cost." A target price of 490p is more than £1 above the current market price.

Derwent London is another new addition to the top picks portfolio, replacing British Land, with the comment that its return profile evolved through FY15 with the mix of returns has shifting from yields to estimated rental value (ERV) growth.

ERVs have been accelerating since early 2013, they remain some way below levels seen in 2006 but, while slowing, are thought likely to remain positive through to 2019.

"Rising construction capacity constraints and cost inflation increase the likelihood of delays across the broader London development pipeline but DLN has locked in construction packages and costs, in pound-terms, on three of its four live developments, and is close to finalising the remaining package for 80 Charlotte St."

While there are macro uncertainties such as the mayoral election and Brexit vote, a strong balance sheet, an attractive development pipeline and significant organic reversion off low passing rents, gives analysts confidence in their 3,850p target price.

Tullow, despite being among the most shorted stocks on the FTSE, remains in the list on analysts belief that Tullow "could be ideally positioned for a future recovery in oil prices", as it is able to withstand a period of low oil prices while completing its major development project, the TEN field offshore Ghana where first oil is due in the middle of this year.

On Vectura, Numis set a price target of 264p, offering around 60% updside to the current price on a 12-month view as the respiratory specialist merges with peer Skyepharma in "one of the most complementary mergers in the UK Healthcare sector", as the enlarged group has competitive advantages in both drug delivery and respiratory formulations and offers exposure to several emerging royalty streams through partnerships with Big Pharma partners.

"Vectura specifically benefits from Skyepharma's fast growing earnings and cash-flow, which will, in our opinion, accelerate the enlarged group's transition to being a specialist pharmaceutical company with the financial strength to commercialise novel drugs and devices in niche segments itself."

House stock Northgate is another new name on the list, with a target price of 560p as the shares are felt to offer an "attractive combination of cyclical and selfhelp growth drivers, income attractions, and a valuation that reflects the historic
changes to the depreciation rates and UK operational issues, rather than the scope for further improvement".

Tate & Lyle was under the cosh on Friday after Canaccord Genuity cut its earnings forecasts ahead of the company’s full year trading update.

Canaccord said recovery in Mexican and Brazilian currencies, reduced interest costs and an increased contribution from joint ventures has been offset by higher than anticipated central costs.

Central costs were driven by a rise in depreciation and amortisation costs, particularly in Tate’s Specialty Foods Ingredients (SFI) business.

Canaccord now expects earnings per share of 33.8p in 2016, compared to a previous estimate of 34.7p and the prior year’s 37.7p. However, the broker said new estimates have been brought in line with current consensus expectations.

“Ultimately, however, we think Tate's share price will be driven by further evidence of stability in sucralose following the transition to a single production plant, improving profitability in HFCS (high fructose corn syrup) and greater focus on SFI, while essentially running Bulk for cash,” said analyst Eddy Hargreaves.

“We remain positive on management's ability to deliver this and note the recent better-than-expected performance from sucralose following the restructuring actions.”

Canaccord reiterated its ‘buy’ rating and target price of 685p, saying the shares have recovered modestly since the third quarter update on 11 February and “remain attractive in our view”.

Berenberg has downgraded Inchcape to 'hold' from 'buy' on new-found concerns for the car dealer's businesses in the UK, Hong Kong and Australia.

Although the stock is cheap on a p/e ratio basis, Berenberg said, the three business account for almost two-thirds of group operating profit and could put earnings per share momentum at risk over the next year.

The concerns in the UK relate to Inchcape's margins declining to their lowest level since 2008 in contrast with the rest of the market, largely felt due to the company's large exposure to Volkswagen in the UK, representing around 20% of retail franchises and where sales have come under pressure last year following the emissions-cheating scandal.

While Inchcape’s management declined to provide exact figures on the UK impact of the scandal, Berenberg believes in the fourth quarter alone it could have amounted to a loss of circa £3m to EBIT - or 5% of full year UK profit.

"With VW sales in the UK down by 13.5% year to date, we believe Inchcape’s UK business could be at risk if this trend continues," the German bank said in its note, with the UK being 20% of 2016 expected EBIT.

As for Australia, which represents 26% of 2016 EBIT, the concerns relate to the big focus on Subaru, which is bought in Japanese yen and so the deprecation of the Australian dollar presents a risk to margins.

"While the company believes that it can share some of this pain with the dealer network, we wait to see how much can be passed on," Berenberg said, rubbing out £3m of its EBIT forecast for the unit and warning it could arguably be more.

Although the Hong Kong dollar's appreciation is expected to generate a £6m tailwind, analysts fear Inchcape’s business in north Asia will not grow at all in EBIT terms in 2016, given the major slowdown in consumer and business confidence there.

Berenberg has cut its price target to 735p, from 915p, on EPS forecasts cut to 54.3p from 55.64p for 2016.