Broker tips: Unite Group, Electrocomponents, Tesco
Morgan Stanley downgraded its stance on Unite Group to ‘underweight’ from ‘overweight’ and cut the price target to 590p from 700p.
It said that while fundamentals are holding up for now, several headwinds could affect student numbers medium to long term.
The bank reckons international student numbers could decline as a result of potentially stricter visa rules for non-EU students, who make up 25% of Unite’s tenants, and because EU students, which make up 9% of Unite’s tenants, face tuition fee hikes following the Brexit vote. It noted that university applications from EU students following Brexit are already down 9% for the academic year starting September 2017.
In addition, it pointed to falling affordability for UK students. “UK students have formed the majority of the increase in undergraduate student numbers in recent years and penetration has grown more among the less affluent than the more affluent. Less well-off students are likely to face increasing affordability issues: i) maintenance grants have been converted to repayable loans, affecting 20% of students (half of whom see the grant as essential for their studies); ii) tuition fees may rise more from 2017; iii) 77% of recent graduates are worried about their student debt.”
MS also said there was a risk of oversupply and softening yields. It estimates the current pipeline of purpose built beds equates to about a quarter of existing beds. According to its channel checks, pockets of oversupply are appearing in some markets and demand for secondary assets is softening.
Electrocomponents got a boost on Friday as Liberum initiated coverage of the stock at ‘buy’ with a 420p price target, which implies total return potential of 18%.
The brokerage said the arrival of a new management team last year has had a dramatic impact on the company’s fortunes.
The implementation of a new three-year restructuring programme, alongside initial signs of delivery, has seen the shares surge more than 50% so far this year.
“Despite this strong share price performance we believe that the potential upside from this strategy is yet to be fully reflected. Beyond this we also see structural opportunities from its unique position in both the industrial and electronic markets to drive long-term shareholder value.”
Liberum said the group was well placed to deliver full-year 2016 earnings before interest and taxes compound annual growth rate of 19%, with the vast majority of this improvement expected to be delivered by self-help measures, such as warehouse rationalisation, with revenue growth accounting for less than a quarter of the uplift.
The brokerage also pointed to innovations such as DesignSpark, which it reckons management will use to drive long-term value creation.
“We expect the company to talk more about its plans in this arena over the next 12 months, and anticipate similar attempts to create value from trends such as IoT and Big Data. Perhaps the best example of this will be in the field of predictive maintenance which is growing across a number of different industries. Beyond this we also see the growing field of Mechatronics – the integration of electronics with mechanical engineering – as providing the company with a long-term platform from which to grow shareholder value.”
Liberum said that while the shares are expensive relative to historic levels, Electrocomponents’ valuation relative to its growth potential leaves it screening positively compared to the majority of its global peers.
Tesco’s shares fell on Friday as Credit Suisse reiterated an ‘underperform’ rating and target price of 130p, citing “structural problems”.
Credit Suisse said while Tesco reported a 34.4% increase in operating profit to £515m in the first half, it was “not from better trading”.
Tesco posted a return to sales growth in the first six months of the year, up 0.6% in the UK. However, pre-tax profit dropped 28.3% to £71m as the supermarket invested in efforts to regain market share amid fierce competition in the sector.
“On October 5, Tesco reported strong UK operating profit, bolstering its claim that the core business is back on track – we are not yet of that view,” said Credit Suisse analyst Stewart McGuire.
“More than 100% of operating profit was generated via cost savings and we estimate that like-for-like sales at its largest stores (which constitute almost 50% of space) remain materially negative once online sales are excluded.”
Credit Suisse said Tesco’s results showed weak free cash flow and a deteriorating balance sheet. Retail free cash flow fell from £281m in the first half of fiscal year 2016 to £203m in the first half of 2017. Total debt rose by nearly £2.5bn to £18bn, even after including one-time disposals of subsidiaries and properties as well as working capital inflows, the analyst noted.
Tesco also revealed a three-year, £1.5bn cost savings programme, which would represent a 2.7% increase in group margin at current trading levels.
“The company has scheduled a capital markets day on 16 November; until then, we remain sceptical of reaching such lofty targets,” McGuire said.
“We incorporate £100m and £300m of net cost savings for fiscal years 2018 and 2019, respectively, but keep our below consensus estimates unchanged.”
Credit Suisse, however, raised its full year 2017 forecast on UK and return on investment earnings before interest and tax by 16%, driven by the cost savings programme. The 2018 and 2019 estimates were also lifted by 17% and 49%, respectively.
The bank increased its UK terminal margin from 2.2% to 2.5% after Tesco restated is like-for-like numbers.
“However, any benefits from these changes are substantially offset by the £3.2bn increase in debt due to pension liabilities,” McGuire said.
“Our discounted cash flow-based price target does not change, and on a multiple basis, shares still appear expensive versus the sector.”