Broker tips: Smith & Nephew, Pennon, Halma

The investment bank said in a note that it has previously rated the company at ‘buy’ on the opportunity for margin expansion driven by a recovery in the Wound business.

“However given (a) slower than expected growth in that division in H2 2015 and (b) 2016 guidance which implies little or no underlying margin expansion beyond known effects, we do not have sufficient confidence in the opportunity to maintain a 'buy' rating.”

UBS also said management commentary suggesting that the tax rate is unlikely to decline further beyond 2016 removes one of the key EPS growth drivers of recent years.

It also noted that the key uncertainty facing investors in the impact of the reimbursement charge.

“From the first of April 2016 the way that Medicare pays for hip & knee replacements for up to 1/3rd of their beneficiaries will change.

“This could result in increased price pressure from surgeons, who are (for the first time) allowed to be paid for finding cost savings.”

But UBS did say it saw a positive catalyst in first quarter results.

“There are three more trading days in Q1 2016 than in Q1 2015, providing a 5% tailwind to growth rates.

“Whilst brokers have factored this impact into their quarterly phasing in the past we believe this could provide a tailwind to investor sentiment in the near term.”

UBS also cut its target price on Smith & Nephew from 1,250p to 1,100p.

Bryan Garnier downgraded its rating on Pennon Group to ‘sell’ from ‘neutral’ following a fairly strong relative performance over the past six months and the fact it is now trading just 9% below its all-time high.

“We appreciate the group’s strategy, especially in the waste business, but see potential uncertainty on UK inflation and power prices as clearly negative for the investment case, especially at current multiples,” it said.

Bryan Garnier noted that Pennon, like other regulated US and European water stocks, has massively outperformed all major indices since the 2008 financial crisis, as investors look for visibility on earnings and above-average real yields.

It argued that at the current price, shares are not cheap.

“While we understand the reasons for this outperformance, we struggle to see how investors can still be attracted to a stock trading at 13.9x 2016/17e EBITDA and 22.5x earnings, versus historical multiples of respectively 11x and at 14.3x, and most importantly, versus the peer group at 10x and 19.x.”

BG added that at 833p the stock is only 9% below its highest ever level while the Stoxx 600 utilities index is trading 50% below.

Bryan Garnier upped its 2015-2019 earnings per share estimate by an average 4.5% due to a slightly better operating performance by Viridor and lower financial charges, and lifted the price target to 825p from 800p.

Halma’s strong performance should not come as a surprise to investors, Investec said on Thursday following the company’s trading update.

The safety, health and environmental technology group said, based on current trading and forecasts, it expected adjusted profit before tax for the year to 2 April to be in line with market expectations.

Halma's board said the company was continuing to benefit from its market diversity, and resilient growth drivers with all four sectors trading in line with the “broad pattern established in the first half of the financial year”.

The Infrastructure Safety, Medical and Environmental & Analysis sectors all made good progress while the Process Safety experienced weakening demand from its oil and gas related customers.

“Halma’ strong performance should not come as a surprise to investors who understand its model, strategy and record, but it is likely to stand in greater contrast to other industrials whose markets are more challenging,” said Investec analyst Michael Blog.

"Today’s in-line Q3 16 trading update extends the record of progress for Halma, a shining beacon in an uncertain Industrial landscape. The shape of trading is very much as in H1, with three sectors advancing and one down.”

Investec expects overall organic constant currency revenue growth of 5% in the second half with margins at least maintained and acquisitions contributing well.

Since the end of the first half, Halma has made three acquisitions including infrastructure safety group Firetrace and medical firms Visiometrics and CenTrak.

Investec reiterated its ‘hold’ rating and target price at 833p.