Broker tips: Sainsbury's, Sky, Northgate

Deutsche said it believed investors were currently reluctant to factor-in the likely earnings accretion due to risks around the execution of the takeover.

Sainsbury’s said it expects the deal to be earnings-accretive in the first full year post completion and double digit accretive in the third full year post completion.

That was based on estimated EBITDA synergies of £120m, but they have since been increased to £160m.

The German bank forecasts in the long-term the synergies from lower Argos costs will generate 4.5p of additional earnings per share, adding 20% to consensus forecasts for the 2018/2019 financial year of 22.4p and 25% on its own forecast of 18.2p.

"Within the context of high fixed costs and slim margins, we think rents are one of the key challenges facing UK food retailers today. The ability to enhance asset turn, and the related cost savings which drive the earnings accretion, is a key attraction of this deal in our view," DB said.

Although Argos’ general merchandise and electricals offering is more cyclical than food, the lower cost base from the merger is felt likely to increase its profitability from its previously 1%-2% margin.

Reading data from Kantar that suggested Sainsbury’s give-away - the value of promotions over total sales - declined circa 2% in calendar 2015 vs 2014, while the market was broadly flat and Big 4 peers were flat or up, indicated Sainsbury’s has achieved the greatest reduction in the level of promotions of the Big Four grocers over the past 18 months.

Analysts think this can contribute to a better margin trend.

With Sainsbury’s shares trading at 13 times consensus 2016/17 earnings, the price "already reflects downside risk to near term earnings", analysts wrote, viewing the risk/reward skewed to the upside.

Sky’s shares fell on Friday as HSBC trimmed the broadcaster’s target price to 1,010p from 1,020p and maintained the stock at ‘hold’.

HSBC said while Sky’s third quarter interims on Thursday were in line with the company’s consensus, key performance indicators were soft in places. “In particular, concerns are likely to centre on churn and net additions,” HSBC added.

Sky won 177,000 new customers in the three months to March, 160,000 fewer than the previous quarter. Both the number of new broadband customers and TV customers eased. The slowdown sent shares lower on Thursday, despite the group reporting a 5% increase in revenue to £8.7bn and a 12% rise in operating profit to £1.14bn in the nine months to the end of March.

“Churn stepped up quarter-on-quarter in the UK (10.7% versus 10.2%) and in Italy (11.0% versus 9.9%). As Sky has lost Champions League coverage in both markets, this raises the issue of the company’s relative competitiveness,” HSBC said.

The bank said its view was that “a number of ‘known unknowns’ provide an overhang” to near-term share performance.

It noted that Germany's federal cartel office has approved plans to stop any single buyer from winning all the live television rights for Bundesliga soccer matches for the four seasons starting in 2017. This would mean Sky, which virtually won all live broadcasting rights in the last auction, would be unable to achieve the same in the next auction.

HSBC said there is also uncertainty over Mediaset Premium’s future plans following its acquisition by Vivendi. Vivendi chairman Vincent Bolloré said he plans to launch a streaming service to rival Sky’s pay-TV outfit and Nexfix.

Meanwhile, the UK outlook is somewhat uncertain ahead of Britain’s referendum on its European Union membership on 23 June, HSBC added.

The 'bears' on Northgate had it all their way last year, but the company's fortunes might be set for a turnaround, analysts at Citi said as they started coverage of the firm's shares with a 'buy' recommendation and target price of 600p.

In 2015, the stock price of the light commercial vehicle hiring company was beaten down by approximately 35%, which analysts Christopher J Mcvey and Rahul Chopra put down to a decline in UK utilisation rates and changes made to how the firm accounted for depreciation.

However, that left the shares discounting "recessionary" conditions in the business, the analysts argued.

That was far too pessimistic, their proxy for gross domestic product - to which the company's top line was tightly-correlated - in the UK was pointing to steady growth, barring Brexit.

In Spain, a recovery was also ongoing, they pointed out.

"We suggest the business is well placed, with a materially stronger balance sheet than pre financial crisis."

Recent changes to its management team in the UK should also help Northgate step on the gas on its already reinvigorated UK performance, they said.

Changing hands on eight times the broker's estimate for the company's earnings for the next twelve months the shares were trading at a 24.0% discount to their historic multiple and at 1.0 times their price-to-book value, which made of an "attractive" valuation, Citi said.