Broker tips: Tullow Oil, HSBC, Sainsbury's

Oil exploration and production companies are in a race against time, waiting for low oil prices to lead to cuts in capital expenditures which are then expected to lead to a rebound in the price of crude, as higher cost producers are squeezed out.

UBS expects physical oil markets to balance out from the second half of 2016 to the above, but the broker admits that investors face a challenge trying to 'time' when markets will begin to price the improving backdrop into the prices of shares in the oil patch.

However, "with Tullow, time is more on your side than one might imagine," the Swiss broker said in a research note sent to clients.

The E&P outfit has 36,000 barrels of daily oil output hedged at $76 per barrel for 2016, roughly half the total, it explained.

Furthermore, UK tax law meant those hedged are taxed at a "low" 20% tax rate, instead of the approximately 40% tax rate applied at well-head.

Therefore, on a post-tax cash basis the company had hedged about 67% of its 'real' barrels for the coming year.

"This is a well-financed company with quality assets and a proven development track-record, offering long-term oil price exposure at the bottom of the cycle, yet well protected at the front," analyst Daniel Ekstein said.

Ekstein reiterated his 'buy' recommendation on the stock and stood by his 240p.

JPMorgan Cazenove downgraded HSBC to 'underweight' from 'neutral' as it sees the Asia-focused bank underperform peers due to the increasing probability of worsening credit in emerging markets.

JPM said it saw valuation downside due to the potential for rising inflows of non-performing loans (NPLs) in emerging markets.

"We expect a modest increase in impairment with risks to the downside in 2016/17, primarily driven by Asia."

Moreover, persistent pressure on revenues is forecast to continue despite rising US interest rates, while JPM saw "little or no growth" to come in the dividends per share (DPS) rate.

The broker noted that the market is already pricing an EM NPL cycle into rival StanChart’s valuation, which has brought its shares down to a 40% discount to HSBC, even though it has a stronger capital position based on CET1 levels and has already cut DPS to preserve capital.

For dividend yield and for its top UK sector pick, JPM said it preferred Lloyds Banking Group.

"We believe management's cost focus is a positive with costs expected to remain flat over 2014-17E on an FX adjusted basis. However, we expect pressure on revenue to continue with the group restructuring $220bn RWAs over this period (ex Brazil & Turkey disposals) and a challenging outlook for redeployment into higher return business (circa $150bn)."

JP Morgan's analysts not only forecast underlying revenues excluding disposals would be flat in 2016 but also saw downside risk to those forecasts, which were 2/3% below the general consensus, with DPS to remain flat at 50 cents in 2015 and 2016.

They did not expect a DPS cut, nor assume neutralisation of the group‘s scrip dividend of circa 30%.

Brokers remained undecided and a little perplexed by Sainsbury's revelation that it is pondering making another takeover bid for Home Retail after a November offer was rejected.

Sainsbury's now has until 2 February to announce either a firm intention to make an offer or that it does not intend to make an offer.

Analysts at Jefferies said they could not decide if the potential deal is "genius or madness", with Shore Capital saying it harboured "more reservations than jubilations".

Societe Generale, which maintained a 'buy' rating on the FTSE 100 grocer, said it believed the main rationale behind the deal was to optimise Sainsbury's retail space, strengthen its non-food offering and benefit from Argos best practices in delivery and online.

Calculating that it has around 150 current stores that have too much selling space, around 6% of its estate, SocGen saw ample opportunity to reallocate this to Argos on top of the 10 trial Argos 'corners' already, which would lead to estimated potential net synergies of just £100-150m.

The French broker assumed a mixed offer of 30% cash and 70% in shares would mean the deal would become dilutive at 140p per Home Retail share with no synergies, or 13% accretive with £100m in net synergies.

SocGen added that it was concerned about the timing of the deal — "although Sainsbury's is doing a good job, it needs to be fully focused on its core business" — and the concern that Sainsbury's would lose its pure player status, resulting in increased risk profile, potential efficiency loss in terms of capex allocation.

For its part, Jefferies said it was either a sign of management's lack of confidence in prospects for the core business or a positive step in anticipating how the customer journey will develop in a multi-channel world.

Jefferies, which retained a 'hold' rating, said the bull case was perhaps the same strategy that is being pursued by Amazon that "consumers' multi-channel journey inevitably leads to a pairing of frequency of spend through repeat food consumption with transaction accretion through non-food purchases - in a cost minimising way to both consumers and service providers".

But examining the bear case highlighted Argos would have a tough act following Amazon without consequences to margins and there would be little Sainsbury could add in non-food multi-channel expertise, while analysts struggled to see meaningful sourcing or fixed-cost savings from the deal, which would therefore place most emphasis on tougher revenue synergies.

With regard to revenue synergies, ShoreCap's Clive Black said he had "been around too long to predicate a deal on the delivery of such an assertion".

Likewise he added that, whilst Argos has heritage in remote shopping, he harboured concerns the chain's ongoing exposure to competitive challenge from pure-play online such as Amazon and subsector specialists such as AO World.

He also struggled to see compelling synergies and said that, while a merger would add Argos' eCommerce capabilities and much-admired hub-and-spoke logistics system, Sainsbury’s also has to acquire a struggling business where problem solving has to be at the core. "Acquiring problems is not always the ideal route to strategic solutions."