Broker tips: SIG, Rolls-Royce, G4S

The group posted a 1.4% drop in revenue to £2.67bn on Wednesday, hurt by foreign exchange movements in Europe and weak trading.

Pre-tax profit increased 31.5% to £51.3m, but it reflected the previous year’s profits being slashed due to costs associated with the disposal of businesses.

Chief executive Stuart Mitchell said that the company’s full year had been “adversely affected” by market conditions. However, he said the company had taken steps to cut costs to support growth in 2016.

“While the group continues to face some challenges this year (minimal product price inflation, competitive backdrop and stretched balance sheet), we retain our Buy in view of an undemanding valuation and some offsetting benefits this year of currency gains, a good start to the year, cost savings and organic growth initiatives,” said Canaccord analysts Aynsley Lammin and Matthew Walker .

“While we highlight the potential medium-term value in the shares, a sustained recovery in Europe and the UK, operating margins moving to over 4.5%, deleveraging and retaining more of the cost savings are required for the share price to see a sustained recovery.”

The analysts said the target price was lowered due to higher debt levels than previously assumed. Net debt at 31 December 2015 increased to £235.9m from £126.9m in 2014.

Canaccord expects earnings per share of 12.2p and 14.0p for 2016 and 2017 respectively. The 2016 estimate was left unchanged from prior projections but the 2017 was down from the previous 14.3p expected.

Shares in aerospace and defence group Rolls-Royce were in the red after Goldman Sachs downgraded the stock to ‘neutral’, removing it from the bank’s Pan European buy list.

It noted that since being added to the list on 29 September 2015, the stock is up 10% versus the FTSE World Europe up 4.5%, despite consensus 2016 EBIT forecasts dropping 35%.

Goldman said Rolls significantly underperformed in the fourth quarter on the back of the November profit warning, but year-to-date the shares are up 23%, versus the FTSE World Europe down 2.3%.

“We continue to expect cash conversion to improve from 2017; however, given the share price performance so far through 2016, we think this, along with the prospect for EBIT improvement (from 2017E onwards), is now reflected in the share price.”

The bank’s 2016-18 EBIT forecasts drop 5%, 3% and 4%, respectively, driven by more significant headwinds in the Large Engine aftermarket and higher costs in the Marine division.

Goldman nudged its 12-month price target up to 725p from 711p.

Barclays downgraded G4S to ‘equalweight’ from ‘overweight’ and slashed the price target to 200p from 310p following the company’s 2015 results on Wednesday.

The security firm said pre-tax profit fell to £78m from £128m the previous year as it highlighted contract provisions of £65m, restructuring of £44m, losses on businesses being sold or closed of £40m and non-cash charges of £106m relating to the amortisation/impairment of goodwill.

It also cautioned that it could lose a further £57m if the UK government decides to extend a contract to house asylum seekers in Britain.

Barclays said that while weakness in the shares makes it tempting to be contrarian and argue this is a buying opportunity, the reality is that a tougher outlook for emerging markets and the UK is likely to mean G4S’s underlying performance remains sluggish.

In addition, it said the path to lower debt is a long one and likely to include a credit downgrade along the way.

“If we had the luxury of ignoring the near term challenges, the business should still offer defensive growth accompanied by self-help and the 12x PE is at the low end of those in the sector.

“However, trading challenges and a dented confidence in management’s ability are likely to mean the shares stay cheap, for the time being.”

The bank cut its 2016 earnings per share estimate to 16p from 18.1p and its 2017 forecast to 16.6p from 20.7p.

On an underlying basis, Barclays forecasts organic growth of 3.2% in 2016 and 3.5% in 2017, below management’s 4-6% estimate.