Broker tips: Hikma, Drax, TT Electronics

In the six months to end-June, Hikma's core revenue rose to $882m, from $709m, but operating profit slipped to $176m, from $204m. Interim dividend was 11c a share, in line.

The drug maker continued to expect revenue in 2016 to be $2bn-$2.1bn in constant currency.

"With revenue expectations for the year unchanged the announcement details several areas where Hikma has made strategic investments for the long term that have repressed near term margins," said Numis in a research note.

"A significant increase in expensed R&D on the differentiated generic pipeline and increased costs of the US Branded sales force has increased underlying costs in the generics business."

"With product approvals in generics delayed (1 product launched, 9 approved), Hikma took on lower margin contract manufacturing that further impacted generic margins."

Numis added that with much work to do in genetics in the second half and into 2017, and recommended Hikma as a 'Hold' with the shares trading on 27-times in full-year 2016.

The brokerage's forecasts for Hikma's ful-year core EBITA and core EPS were unchanged at $382m and 111c respectively, these being in keeping with consensus.

"This clearly leaves much to do in H2 with ongoing glycopyrolate sales potentially driving an upgrade to guidance that is already anticipated in our forecasts. The outlook for FY17 is less clear."

In a first-half trading update on 4 August, the drug maker said it expected full year core operating profit of its generics arm to be between $30m and $40m, compared to $46m in 2015.

Citigroup upgraded Drax to ‘neutral’ from ‘sell’ as an 8% drop in the share price since the beginning of the month has left the shares trading near the bank’s unchanged 305p price target.

Citi noted that despite the recent rally in oil and gas prices, Drax shares have underperformed and it is now more fairly valued.

“We believe the current valuation now fairly reflects the risk/reward profile of the shares and therefore we upgrade,” it said.

Citi said its downgrade of the stock had been a call on inconsistency between commodity prices and Drax valuation, which in its view have played out.

“News flow relating to the European Commission approval of Drax’s third unit biomass conversion into contract-for-difference could still surprise on the downside. However, given Drax’s recent share price movement despite higher oil and gas prices, we now believe more risk is being priced in for a lower CfD.”

The bank said the maximum level the EC has indicated it will allow Drax to earn on the CfD is £100 per megawatt-hour, and it assumes £99/MWh within its forecast and valuation.

On the upside, Citi noted the UK government is currently reviewing the case for new nuclear in the UK.

“If a decision to scrap plans for new nuclear were to come, we believe the UK government could also announce plans to introduce additional incentives to build new combined cycle gas turbines or they could postpone the closure of coal to beyond 2025. Such move could support gas prices (therefore UK power prices), which could benefit Drax’s earnings and valuation in the longer term.”

TT Electronics shares gained on Wednesday as Canaccord Genuity raised its rating on the stock to ‘buy’ from ‘hold’ and lifted its target price to 180p from 165p.

Canaccord said TT Electronics’ first half results on 11 August showed strong progress across the group and “we have become increasingly confident in the company's ability to deliver its target of sustainable, profitable growth in the medium term”.

“This is a very different and, in our view, much improved business to three years ago; however, current valuations (FY2 PE 12.2x vs. 3yr avg. 12.6x) do not appear to reflect this.”

The British maker of automative parts reported a 25% increase in first half pre-tax profit to £11.4m on a 5% rise in revenue to £277m, driven by its Transportation Sensing and Control division returning to profitability. Underlying operating profit increased by 32%to £13.7m. The acquisition of electronics manufacturer Aero Stanrew in December 2015 and ongoing improvements in cost efficiency also supported the figures.

“With demand for electrification, automation, and connectivity increasing, the structural drivers are attractive, and we believe TT is becoming progressively well aligned to capture these trends,” said Canaccord.

“A key component of this is the continued investment in research and development, which the company has grown +20% over the last two years to c.6% sales (ex. IMS).”

Canaccord said downward pricing pressures remain a headwind, particularly in the Transportation Sensing and Control division, but the broker expects the new product cycle and operational improvement initiatives to offset the risk.