Broker tips: Morrison, Kingfisher, Ashtead, Admiral

The bank pointed out that Morrison has one of the strongest balance sheets in the sector, a capital light growth plan, self-help opportunities, is close to net cash and has one of the most attractive cash flow valuations in the sector.

“We believe that its strong balance sheet position and resultant cash optionality deserves a premium,” it said, adding that it looks as if the stock is trading on a 20% discount versus the sector.

Merrill said chief executive officer David Potts’ key strategic moves have included a new wholesale partnership with Amazon and Rontec and renegotiation of its Ocado contract. All of these moves should help to expand future earnings without the need for significant capital, it argued.

Merrill said the continued deleverage suggests the group could turn net cash in 2022, suggesting the price-to-earnings ratio will de-rate as debt continues to decline.

The bank’s base case scenario is for EBIT margins to stay flat in 2018E at 2.6%.

Its upside scenario is that Morrison moves to share profitability of its wholesale business and greater than expected efficiencies in store could mean operating margins rise to 2.75%, an increase of 0.15% from the base case.

A downside scenario would see a sizeable amount of unpassable food inflation, which could lead to margin contraction to 2.5%.

Kingfisher

Analysts at Barclays initiated B&Q and Screwfix owner Kingfisher as ‘underweight’ as it expects macroeconomic headwinds in both Britain and France.

The bank said the FTSE 100 company is facing difficult macro and market share losses in France that are unlikely to be resolved quickly and so initiated an ‘underweight’ rating and a target price of 300p.

Although it does believe that Kingfisher’s five-year plan to turnaround its prospects “makes sense”, but it could disrupt operations in the short term and negatively impact its financial results.

During the first year of its turnaround plan Kingfisher unified 4% of its products across its different chains, but included what Barclays believes are “low hanging fruit”, as the company is also planning to increase its unified ranges to 20%, which may result in “excessive inventory that will need to be discounted, potentially unwanted new items and a cultural clash with divisions that have been used to more autonomy”.

Barclays believes that Kingfisher will find it difficult to grow sales over the next year as its French subsidiaries have experienced a continued decline in profitability since 212 when the gap between UK-based B&Q’s sales and that of Brico Depot and Castorama peaked.

Despite trading slightly below its five-year average price-to-earnings ratio, Barclays said that its stock is already pricing in some improvements and that company-collected consensus is too high.

The biggest risk to Barclays' forecast is "faster than expected benefits from the current turnaround plan".

It said that it was possible that a "unified range" will be popular with consumers and simplify operations, but this is unlikely, while macro improvement in France and Britain could surprise the market on the upside.

Ashtead

Liberum initiated coverage of equipment rental company Ashtead at ‘buy’ with a 1,940p price target, saying the upside potential from increased rental penetration in the US market is yet to be fully reflected in the share price.

The brokerage said its detailed analysis of management’s medium-term growth plan, ‘Project 2021’, suggests that it is well placed to deliver 9% per annum underlying revenue growth and further improve its sector leading margin.

“Our detailed analysis of this plan leaves us to believe that it is well placed to deliver on its targeted 875 stores by 2021 via a healthy combination of organic growth and bolt-on acquisitions. With the maturation of its existing footprint augmenting growth from new locations, we forecast local currency revenue growth of 9% p.a. over the FY16-20 period.”

With this growth funded internally, Liberum expects the leverage to reach just 1.3x in FY19, providing management with significant optionality to further accrete shareholder value.

The brokerage also pointed to the fact that government policy in the US is supportive of higher levels of infrastructure investment, saying that a it phase of fiscal expansion could provide an important source of momentum for the rental industry.

“This combined with potential changes in the corporate tax system in the US suggests that changes in government policy could be supportive for Ashtead in the short and medium term.”

Having said this, Liberum made it clear that its investment case is not dependent on any of these proposals and would see their enactment as “nice to have” rather than central to the investment case.

Admiral

RBC Capital Markets upped its stance on insurer Admiral to ‘sector perform’ from ‘underperform’ and bumped the price target up to 1,925p from 1,650p.

The bank said it was updating its estimates following the full-year 2016 results. In 2017 and 2018, its earnings per share forecasts rise by 8.5% on average as it reckons Admiral will achieve higher premium growth and profitability in the UK Motor business.

RBC also said it expects the Ogden discount rate used to calculate lump sum payouts for personal injuries will ultimately increase, which will boost Admiral's solvency position.

The bank noted that in her decision on the Ogden discount rate review, Lord Chancellor Liz Truss said that a consultation would take place around Easter 2017 to consider whether the current methodology in setting the discount rate is appropriate.

“We see potential for the Ogden rate to rise following the consultation. From our analysis, at 0% discount rate, Admiral’s FY16 Solvency II ratio will improve by 15%pts from 212% to 227%. Looking ahead to FY17E, we expect a Solvency II ratio of 241% (pre-dividend), which would improve to 258% were the Ogden rate revised to 0%.”

Earlier this month, Admiral reported that its full-year profits fell by a quarter due to the government's changes to the Ogden rate, though the non-life insurer's hefty dividend was held steady as underlying profits edged higher.

The upgrade from RBC came as the government on Thursday unveiled its consultation into the future of the discount rate for personal injury payouts after insurers were forced to make large write-downs against future claims.

In a written parliamentary statement, Truss said the consultation would look at whether the rate should in future be set by an independent body.

She added that it would investigate whether more frequent reviews would improve predictability and certainty for all parties; and whether the methodology – which in effect assumes that claimants would invest only in virtually risk-free index-linked gilts - was “appropriate for the future”.