Broker tips: Dunelm, BBA Aviation, Pearson

HSBC said the home furnishings retailer has strong management and an attractive business model with high margins, cash flow and returns.

“It is the leading UK homewares retailer with exposure focused at the low ticket end of home spend but with growing exposure to furniture from a low base,” the bank said.

“Operating margins of around 15% are supported by an efficient cost structure, with Dunelm able to accept lower gross margins than many incumbents while still generating high operating margins.”

The bank said Dunelm is able to generate substantial amounts of cash flow with free cash conversion at more than 80% of net profit with a capital light model, even while growing its store base.

“This and a conservatively geared balance sheet support strong returns to shareholders, with special returns announced in each of the past four years.”

The company has a market share of 8%, which implies a greater degree of fragmentation than other categories such as grocery, clothing, electricals and DIY.

HSBC expects future share gains will be achieved through like-for-like (LFL) outperformance and rollout.

“LFL growth is sensitive to the consumer backdrop but should be supported by a number of strategic initiatives under the new management team led by John Browett. These include further investment in online, category expansion, and increased focus on customer service.”

In the long-term, HSBC sees potential for the business to deliver earnings of more than 78p at 200 stores with online penetration of 20% of sales.

BBA Aviation got a boost on Thursday as Barclays initiated coverage of the stock at 'overweight’ with a 280p price target.

It said that operating in an attractive market with excellent market positioning, there are two potential areas for further share price upside.

The first is the Landmark acquisition, where integration is going to plan and cost synergies are marginally ahead of expectations.

Secondly, Barclays said that thanks to very strong cash generation, it sees scope for the group to deleverage quickly and expects BBA to review its target capital structure in 2017, allowing for incremental shareholder return potential over the medium term.

The bank said BBA’s Signature Flight Support business is a unique asset, with leading share in an attractive market providing aviation services for the business and general aviation market.

“A decent long-term growth profile underpinned by both cyclical and structural factors is further strengthened by BBA’s track record of growth ahead of the market, which we see as sustainable as the company begins to take advantage of network benefits from the Landmark acquisition.”

Barclays said that on an earnings basis, BBA trades more or less in line with the FTSE 250 but looks more attractive on a dividend yield basis, and offers a growth profile that is ahead of the market.

Exane BNP Paribas downgraded education publisher Pearson to ‘neutral’ from ‘outperform’ and cut the price target to 900p from 1,000p saying it fears more turbulence ahead.

The bank said that after last year’s shock profit warning, Pearson has needed to deliver on expectations to rebuild confidence. However, the US higher education courseware market looks weaker-than-expected despite signs of an improvement in enrolment over the summer.

“This raises the risk of a further setback at the Q3 results,” it said.

Exane cut its 2016 earnings per share estimate by 6% and its 2017 forecast by 5%, saying it was concerned consensus might have to revise 2016 forecasts lower following the third-quarter results.

In addition, it noted that US peer John Wiley & Sons pointed to a weak market in July.

Exane said its industry contacts suggest August was below expectations too and it reckons this weakness was largely caused by destocking at bookstores. It said market share gains were unlikely to be enough to offset industry weakness.

“We continue to anticipate an organic revenue growth recovery next year. The stock remains on sector and peer group relative lows and offers a sustainable dividend yield of 6.6%.

“But we have concerns on 2016 trends and believe there might be better entry points to play the expected 2017 turnaround later next year. We see more compelling ideas elsewhere in Media.”