Broker tips: Smiths Group, AB Foods, Micro Focus

JP Morgan said the technology company's 2016 financial year ended on a “very positive note”, with the trading update on 9 August indicating that full year operating profit was well ahead of consensus expectations of £473m, although below the 2015 level of £511m.

“The full-year (July year-end) results on 28 September are to be accompanied by the presentation of the new management team’s strategic vision for the group and we expect this, together with good results for 2016, to provide a further stimulus for the shares to continue to outperform the sector,” JP Morgan said.

“With 18% upside to our price target and the prospect of the positive news flow continuing, we are reiterating our ‘overweight’ recommendation.”

JP Morgan raised its 2016 revenue and earnings per share forecast by 2% to £2.93bn and 81.7p respectively, given the movement in exchange rates.

The broker said Smiths is trading at a “substantial discount” to the sector in terms of price-earnings ratio and enterprise value/ earnings before interest, tax and amortisation multiples “despite the prospect of delivering an operating profit margin more than 400bps above the average for our universe”.

RBC Capital Markets upgraded Associated British Foods, but downgraded Debenhams and Sports Direct as it took a look at the European general retail sector.

“The general retail sector has bounced back from a post-Brexit selloff. However, we still see opportunities to buy stocks likely to see upwards earnings revisions.

“We favour higher quality merchants and online retailers and we are more cautious on companies likely to see like-for-like sales and margin pressure in H2 and 2017.”

The bank upped AB Foods to ‘outperform’ from ‘sector perform’ and lifted the price target to 3,400p from 2,800p.

It noted the shares are down 12% year-to-date but said its full-year 2017/18 earnings per share forecasts are 6% higher than at the start of the year.

“We think ABF has a healthy double-digit EPS compound annual growth rate with EPS momentum owing to Primark share gains and recent strength in Sugar and euro prices. Our survey work favours Primark which still offers an attractive international rollout story.”

On the downside, RBC cut Sports Direct to ‘underperform’ from ‘sector perform’ with an unchanged target price of 280p.

It said Sports Direct shares have reacted well to the company's plans to buy back up to 5% of shares.

“However, our FY18 earnings before interest, tax, depreciation and amortisation forecast is still well below consensus (14%) given cost and currency pressures and as we think it will be challenging for SPD to raise prices when consumer disposable incomes are being squeezed.”

The bank also downgraded Debenhams, to ‘sector perform’ from ‘outperform’ with an unchanged target price of 65p.

It said Debenhams remains cash generative and according to its survey work, retains a range advantage over other retailers.

“However, it is relatively geared into a weaker outlook for consumer disposable incomes and also faces a more price competitive mid-market clothing sector.”

RBC said that while the stock’s valuation is undemanding, like-for-like and EPS growth will be challenging given consumer and dollar sourcing headwinds.

Canaccord Genuity has cut Micro Focus International’s rating to ‘hold’ from ‘buy’ but lifted its target price to 2,000p from 1,700p.

“We are updating our price target and forecasts to reflect the better-than-expected recent full year results and the impact of dollar strength,” Canaccord said.

“We are also moving our recommendation from ‘buy’ to ‘hold’ as we expect the shares to pause for breath following a strong run. Our price target moves from 1700p to 2000p to reflect the beneficial impact of a stronger dollar and c10% upgrade to our earnings forecasts.”

On 14 July the software product group reported a 59.1% increase in underlying adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) to $532.5m on a 54.9% jump in revenues to $1.24bn on a constant currency basis. Micro Focus said the results beat its expectations, driven by a strong performance of its product portfolio under its data and cloud storage business SUSE where revenues grew 18.2%.

Canaccord has raised its EBITDA estimate for fiscal year 2017 to $639m from an earlier forecast of $556.1m following the results. The broker’s net debt estimate of $1.3bn represents just over two times this EBITDA forecast.

“The Micro Focus management team maintains an efficient balance sheet and one consequence of this was a final dividend increase of over 50%. This leaves the stock yielding just over 3% despite the recent strong performance of the shares.”