Markets live chat transcript for the chat ending at 12:15 on 7 Jul 2008. Participants in this chat were: Neil Hume (NH) Paul Murphy (PM)
PM:
Im the slow coach this morning
PM:
This is Markets Live — FT Alphaville’s daily markets commentary
PM:
Neil wants to go to a piece of RAW immediately
PM:
But I should add that while this is raw untested market gossip
PM:
It comes from a gossip who tends to be right
NH:
has a very good record recently
PM:
So, no guarantees — but we are pretty sure something is going on here
NH:
but we will have to head to the home of the new Wimbledon champion for this piece of RAW
NH:
stock in question is Iberdrola
NH:
massive volume already this morning
NH:
41m traded, against a daily average of 50m
NH:
stock has spiked almost 7% to EUR9.23
PM:
so what’s going on??????
NH:
well, lets get something straight first of all
NH:
41m of these have not changed hands because of this report
NH:
EDF, the French electricity group, and ACS, Spain’s largest construction group, have held preliminary talks about a joint bid for Iberdrola, Spain’s largest utility, politicians and investment bankers said.
Iberdrola’s share price has risen 21 per cent in the past week, to Euros 9.23 at yesterday’s close, on rumours of a possible bid.
The company said yesterday it had not received any approach. However, Iberdrola has long been viewed as an attractive takeover target. It is the world’s biggest producer of wind energy and it owns Scottish Power in the UK.
NH:
The company recently raised Euros 4.5bn (Dollars 6.6bn) by spinning off 20 per cent of its renewables division.
Both ACS, which owns 7.7 per cent of Iberdrola, and EDF declined to comment.
But investment bankers said the two companies had held preliminary contacts about mounting a joint bid for Iberdrola, which has a market value of Euros 46bn.
They added that Nicolas Sarkozy, the French president, and Jose Luis Rodriguez Zapatero, the Spanish prime minister, were aware of the talks.
ACS is also reported to have briefed senior political figures of the Popular party, Spain’s conservative opposition, in an attempt to keep the issue out of domestic politics ahead of a general election on March 9.
People familiar with the matter said ACS and EDF would carve up Iberdrola between them. EDF would keep Scottish Power and a 5-10 per cent share of the Spanish electricity market.
ACS, which controls 40 per cent of Union Fenosa, a smaller Spanish utility, would merge Iberdrola’s renewables division and some of its hydroelectric power plants with Union Fenosa.
ACS began building a stake in Iberdrola in 2006 with a view to brokering a tie-up with Fenosa.
NH:
if you believe that has triggered then you are living in a cloud cuckoo land
NH:
what we are being told
NH:
is rumours of fresh interest from EDF
PM:
thought they were chasing British Energy
NH:
but we think their interest had cooled
NH:
and we know they have looked at Iberdrola before
NH:
in fact the FT broke the story
NH:
and it drew a furious response from the Spanish
NH:
published in February
NH:
EDF, the French electricity group, and ACS, Spain’s largest construction group, have held preliminary talks about a joint bid for Iberdrola, Spain’s largest utility, politicians and investment bankers said.
Iberdrola’s share price has risen 21 per cent in the past week, to Euros 9.23 at yesterday’s close, on rumours of a possible bid.
The company said yesterday it had not received any approach. However, Iberdrola has long been viewed as an attractive takeover target. It is the world’s biggest producer of wind energy and it owns Scottish Power in the UK.
NH:
The company recently raised Euros 4.5bn (Dollars 6.6bn) by spinning off 20 per cent of its renewables division.
Both ACS, which owns 7.7 per cent of Iberdrola, and EDF declined to comment.
But investment bankers said the two companies had held preliminary contacts about mounting a joint bid for Iberdrola, which has a market value of Euros 46bn.
They added that Nicolas Sarkozy, the French president, and Jose Luis Rodriguez Zapatero, the Spanish prime minister, were aware of the talks
NH:
ACS is also reported to have briefed senior political figures of the Popular party, Spain’s conservative opposition, in an attempt to keep the issue out of domestic politics ahead of a general election on March 9.
People familiar with the matter said ACS and EDF would carve up Iberdrola between them. EDF would keep Scottish Power and a 5-10 per cent share of the Spanish electricity market.
ACS, which controls 40 per cent of Union Fenosa, a smaller Spanish utility, would merge Iberdrola’s renewables division and some of its hydroelectric power plants with Union Fenosa.
NH:
ACS began building a stake in Iberdrola in 2006 with a view to brokering a tie-up with Fenosa.
PM:
So just to be clear — FT wrote up the story in February — its meandered on — and the the Spanish press came out with that stuff at the weekend
PM:
so, you believe EDF has renewed its interest
NH:
that’s what I am hearing
NH:
apparently some sort of contact was made at the weekend
PM:
so this is not a case of stale bulls trying to puff a position
NH:
although a few people are sceptical
NH:
and are pinning this morning’s advance on the story above
NH:
now its quite possible Iberdrola and Gaz Natural do get together in order to fight off a bid from the French
PM:
Just to clarify I am reprinting the stuff from wires:
PM:
Repsol
In an interview with Barcelona newspaper La Vanguardia, Repsol's Antonio Brufau said a merger between the two still makes sense after he twice failed to buy Iberdrola when chairman of Gas Natural in 2000 and 2003.
"That interest continues. The project makes sense," said Brufau.
Oil producer Repsol controlled Gas Natural at the time of the failed acquisition and it still owns 30 percent.
A merger would protect both companies from French interest.
NH:
yep, sorry about that
NH:
that was the wire story I meant to have printed earlier
NH:
goes to show that the Spanish are worried about foreign bids for their utility companies
NH:
actually just been looking at some of the recent cuts
NH:
on these EDF/Iberdolra saga
NH:
the Spanish have been kicking up a right fuss
NH:
this was in the FT in Feb
NH:
Iberdrola of Spain on Wednesday stepped up its pre-emptive attack against EDF by filing a formal complaint against the French state-controlled electricity group with the European Commission.
The Spanish electricity utility, identified by EDF as a takeover target, claims EDF is illegally “shielded” by the French state against foreign shareholders. It says a “golden share” in EDF retained by Paris was designed to “dissuade potential investors from any member states of the European Union”. In a filing on Wednesday, Iberdrola
NH:
formally asked the commission to investigate whether France is in breach of European law.
The move comes a month after the Financial Times revealed that EDF and ACS, the Spanish infrastructure group, had held talks on a joint offer for Iberdrola.
One option is a break-up of the target, which would allow ACS to fold some of Iberdrola’s generation assets into Union Fenosa, a smaller Spanish utility it controls with a 45 per cent stake.
Both companies have since admitted to their interest, while Iberdrola has been building its armoury for a possible defensive campaign.
NH:
Ignacio Sanchez Galan, Iberdrola’s chairman, last week took a swipe at economic nationalism in France, and warned against any takeover move by EDF. “European electricity groups are looking at France, waiting for it to restructure its energy market and open it to the rest of us,” he said.
The complaint formalises Iberdrola’s opposition to EDF’s ownership structure, under which the state controls nearly 85 per cent of the capital and nominates most of the board.
Although unlikely to force change in EDF governance in the short-term, the action makes clear Iberdrola’s opposition to any approach from EDF and could work as a stalling tactic, say lawyers.
PM:
So the stock is flying
PM:
Feels like a deal is finally near
PM:
One to watch v v closely
PM:
Before we look at the wider market — lets go to some questions below
PM:
Minerva — we dont know more than the story in the Sunday Tel
PM:
Saying talks with the Dubhai lot were off
PM:
But that seems to have been in the price — off 2.5p at 70p this morning
NH:
but what I would say is that down at 70p, the market seems to have already decided there will be no bid
NH:
a note out of Kaupthing last week, said that in the mid60′s, Minerva was trading around the level of its cash balances
PM:
Nothing on TCI im afraid
NH:
as for Rank, that looked like it fell 12% on Friday because of some bungle in the closing auction
PM:
As for Driss Ben-Brahim — moving from Goldman to GLG
PM:
Id give you this blog link
NH:
market treading water ahead of Wall Street reopening
NH:
been flat for most of the morning
NH:
but taken on 18.3 points to 5,431
NH:
largely on the back of good showing from the heavyweight oils stocks
NH:
but if it close below 5,385 we will be in bear market territory
NH:
and will be ripping up the front page to do a big piece on the bear market
NH:
complete with picture of grizly bears
NH:
and lots of depressing charts
PM:
Actually, on that point…
PM:
Here’s the view from Credit Suisse
PM:
global equity strategy
PM:
On 2 May we told clients to de-risk and on 9 June (see “Asset allocation: rising risks”) we called for a 10% correction. We are less bearish than a month ago. But to go overweight equities we would need to see genuine capitulation, value (i.e.1,200-1,220 S&P 500), ECB to cut rates or oil to fall to sub-US$110/bbl.
What’s worse than March? High oil prices, which are now affecting inflation expectations and causing central banks to raise rates-hence, US bonds have not rallied as equities have fallen (bad for both equity valuation and the refi effect); the sentiment indicators are more complacent; emerging markets have clear signs of a wage/inflation spiral; and finally, there’s no silver bullet (apart from falling oil). What’s better than March? Some US$320bn of capital raising by banks (hence, LIBOR is better behaved); US housing down-cycle is more advanced while some US economic indicators have temporarily stabilised; and, above all, despite inflation expectations at a 20-year high, US wage growth is decelerating.
PM:
What are the problems?
(1) Our composite tactical indicator is not quite at capitulation levels. It’s 0.8 std below average now compared to 1.3std below on 21 January and 17 March. We also fear that we need more capitulation now than at previous lows. In particular, equity sentiment is only 1.2std depressed (compared with 1.5std and 1.7std at the January and March lows) and insider and corporate net buying has remained surprisingly subdued. The main good news is that markets are approaching oversold levels (14% stocks above 10-week MA – the buy signal is sub-20%) and cash levels are high.
(2) No clear cut value. The S&P 500 equity risk premium is, on our earnings numbers, 4.1% versus a long-run average of 3.4%. The appropriate equity risk premium depends on credit spreads and lead indicators-and currently should be 4.8% (and 4.4% by year-end). A simple and rather stable measure of value-the sum of P/E plus inflation-suggests fair value for the S&P 500 of 1,275 (year-end inflation of 5% plus a P/E ratio of 17x trend earnings). Our year-end targets are lowered marginally from 1,350 to 1,300 (S&P 500) and from 340 to 320 (Eurostoxx) but we would want equities to be clearly cheap against these targets before we would consider buying.
PM:
(3) Earnings. We now forecast a 5% EPS fall in the US for 2008 (cf. consensus of +9%) and a 13% fall in European earnings. In the US, we believe trend EPS is US$75 (compared with 12-month forward consensus of US$100).
(4) Economies from bad to worse. The US stagflation proxy is at a 30-year high; we believe global GDP will slow to 2¾% (we had thought 3¼%). European growth is likely to slow to 0.5% from 3.2% in Q1E. Above all, the de-leveraging process has hardly started: loan growth is still double digit in the US and Europe. Oil is now close to the crunch point from a policy and growth point of view, but to get oil to fall we probably need a 7% fall in Western demand and that might require a recession! The risk is that central banks focus too much on inflation and exacerbate de-leveraging.
(5) Normally, in a recession, equities decline by 28% over 13 months. So far the S&P is down 19%
PM:
In our view, credit offers good value but not clear cut and typically rallies only as corporate fundamentals (FCF, leverage) improve. We raised credit to overweight on 11 March and halved the overweight on May 2 but still prefer credit to equity and thus keep a small overweight of credit. We stay benchmark bonds, having raised gilts to overweight when yields breached 5.1%.
NH:
so he thinks there is another downward leg to go
NH:
that’s pretty much the consensus view at the moment
PM:
yes, but people still looking for evidence as to when it might turn
PM:
Indeed, we had stuff from Teun Draaisma out this morning
PM:
Piece went up earlier on the AV home page
PM:
A detailed look at trough valuations highlights the dangers of the crowded momentum versus value trade.
In this piece we take a detailed look at how current valuations compare with historical trough valuations for the market and for sectors. We highlight the dangers of the crowded momentum (Global Cyclicals, Commodities and EM plays) versus value (Financials and Consumer Cyclicals) trade for sectors. The momentum sectors are (or are close to being) more expensive than ever, relative to the market, while the value sectors are (or are
close to being) cheaper than ever, relative to the market. Our consensus positioning survey shows that investors are long momentum and short value. There are valid reasons for this, of course, and momentum has worked well, and value has not. But at some point we believe the pendulum will swing back to value. The possible triggers for this are interrelated: when the oil price falls, or when inflation peaks, or when EM slows down meaningfully. We think all may well happen in the next few months, but it won’t pay to be early on this call.
NH:
and he is spot on with the emerging markets and mining stuff
NH:
both have started to wooble since mid-May
NH:
I wonder if things are turning
NH:
and especially on the mining sector, analysts just keep coming out and saying everything is OK
NH:
just makes me worried
NH:
not that I would be recommending a switch into the banking sector
PM:
Sure — moving from the momentum side to the alleged value side of the equation…
PM:
The banks
PM:
Sitting here looking at RBS.
NH:
All those investors who put up £12bn are now more than 13 per cent underwater.
NH:
This is RBS – not some jumped up former building society
NH:
This is down to Simon Pilkington – head of bank research at Caz
NH:
He’s done a 25 page note on RBS — looking at corporate lending, property, ABN in depth, capital position. The works.
NH:
We see two risks that distinguish RBS from its peers; the
exposure to weakening corporate credit quality and the
uncertainties from the acquired ABN balance sheet.
RBS is more exposed than its domestic peers to the UK
corporate sector by the size of its loan book (£167bn) and
the starting point of a low impairment charge. We expect
the charge to rise by £2.9bn over the four years to 2010E,
reducing EPS by 12p.
NH:
Our assumption for impairment is
consistent with Barclays and a little below HBOS.
We reflect a weaker economic outlook, but not a full
recession. A return to a ‘1992 scenario’ would cut earnings
by a further 17p or 54%.
NH:
ABN represents one_third of the balance sheet of RBS yet
it will add just 1% to EPS by 2010E, on our estimates. It is
not the prospect of a dismal return on investment of 7%
that is our main concern. The large balance sheet has the
curious characteristics of a high income yield, but a low risk
weighting for regulatory capital, which we do not regard as
sustainable.
NH:
If successful, the disposals would lift core tier 1 to 6.5%.
There is uncertainty over the quantum, but broadly we
expect the pro_cyclical effects of Basel II to keep the ratio
closer to 6%.
We expect the disposals to dilute EPS by 11% leaving RBS
at a 30% premium on PER 2009E. The price/book at 1.2x
is low and, in equilibrium, could be justified by the expected
return of 13% in 2009E. In common with the sector, we see
the risks to estimates still lie to the downside but, given its
exposures, feel that the newly_gained premium valuation of
RBS will erode. We change our recommendation to
UNDERPERFORM (from In_Line).
PM:
That’s pretty hard core stuff
PM:
… from the broker to Barclays
NH:
Well Barclays is actually up
NH:
0.5p better at 279.5p
NH:
so the new investors still offside here
PM:
But still under the rights?
NH:
Oh yeah. 271p – versus 275p cash call price.
PM:
And how about Bbbbbbbbbb…..
PM:
Tripartite Authorities code name for Bradford & Bingley
PM:
Now off 13.5p at 43.4
PM:
21% below the price at which Britain’s heroic institutional investors stepped up to the plate – filling the gap left by those flaky Texans?
NH:
That’s right. Slew of horrible UK press over the weekend of course.
NH:
But there is also this little upbeat research number from Bruce Packard at Pali International
PM:
Oh go on share, I like his stuff.
NH:
BB/ LN – Dowgrade to SELL, Target Price = 0p
PM:
0!! What’s before the zero?
NH:
Nothing – his price target is zero pence.
PM:
Ha – at least it’s a round number
NH:
Actually if you go into the detail Packard actually comes up with a net present value of minus 14p on a stand-alone basis.
NH:
Walking, or running away?
We have downgraded BB/ to SELL and reduced our Target Price to Zero (previously, Neutral TP 130p). We believe deposit-holders’ money is safe, but from an equity shareholder perspective, we believe that the investment is unattractive on a risk/reward basis. An ‘embedded value’ type approach (with admittedly pessimistic assumptions on margins and cumulative write-offs) suggests a Net Present Value of -14p on a stand-alone basis. The closer to this value BB/ falls, the greater the likelihood of a bid from another UK bank (30% of BB/ operating costs £280m, taxed and put on 10x multiple would suggest synergy value alone of 129p per share), but we doubt that much of this synergy value would accrue to BB/ shareholders in the form of a bid premium.
NH:
Moody’s has announced that it has downgraded BB/’s senior unsecured and long-term debt ratings to Baa1 from A3, on: i) substantial deterioration in the bank’s asset quality so far in 2008; ii) The expectation that asset quality will weaken over the rest of the year; and iii) BB/’s obligation to acquire mortgages from GMAC.
That is the reasons given for the downgrade are already in the public domain: the rating agency is simply catching up with events.
TPG has invoked a clause in its agreement with BB/ allowing it to withdraw from the capital raise if the company is downgraded; however M&G, Legal & General, Insight Investment and Standard Life will support the entire £400m rights issue at 55p/share.
Given pressure on rating agencies to be quicker to downgrade, we think that an agency downgrade to BB/ was probable, in which case we have to wonder why its Executive Chairman allowed TPG to insert the clause.
NH:
Cost of funding or bad debts?
Possibly the clause was not up for negotiation because TPG knew its investment case was highly sensitive to BB/’s cost of wholesale funds (in FY 07, BB/’s interbank and wholesale funding was over £25bn). But BB/ Investor Relations denied this was true when we spoke to them, saying that the downgrade would not make much difference to the bank’s cost of funds. We asked for a second opinion from a contact in the debt markets who told us that, to a large extent, the money markets had ‘priced in’ the well-known problems at the bank. The five-year senior CDS spreads were already trading at 270bp before the news broke, and rose another 100bp following the downgrade. Note that although this level of pricing does reflect concerns in the debt market, it is not indicative of the entire bank’s cost of funding: for example, maturities of less than one year (which is where all UK banks are currently funding at the moment), were expected to rise by 5-10bp on the news of the downgrade according to our source. But to put this into context, 10bp equates to £25m of the entire wholesale book, versus FY 07a PBT ex write-downs of £350m. So based on that information, we think it is unlikely that the downgrade really changed the investment case for TPG.
NH:
It is possible that the Chairman agreed to the clause because he knew a rating downgrade would not be a ‘deal breaker’, but in that case he effectively handed TPG a valuable ‘free option’ to walk away. We seriously question his logic in denying Clive Cowdery access to the books on the grounds that TPG offered “certainty”.
Instead of a changed cost of funding, there is also the probability that more information became available to TPG on the arrears deterioration of the Self Cert and Buy to Let books, and the downgrade provided an escape route. This would have negative implications for HBOS in our view, although the Specialist book at HBOS only accounts for one-third of total mortgages, and HBOS, on the latest data, is reporting a lower level of 3-month+ arrears (1.89% end May) than BB/
(2.49% end April).
NH:
Right we do have a little bit of RAW
NH:
which we have been following quite closely
NH:
we mentioned last week that we thought
NH:
JPMorgan Cazenove had been drafted into to help Inmarsat with a bid approach
NH:
and Harbinger, its biggest shareholder and mooted bidder, had appointed Merrill Lynch
NH:
well it seems the Wall Street Journal agrees with us
PM:
Harbinger Capital Partners, the activist hedge fund that owns 28% of London-based Inmarsat, recently hired Merrill for advice on the holding, according to people familiar with the matter.
PM:
Harbinger is considering a bid for the rest of Inmarsat, which Harbinger could combine with its other satellite holdings, one of these people said.
PM:
Not that long ago, in fact, Inmarsat was a Merrill client. Merrill underwrote Inmarsat’s IPOT in 2005, along with Morgan Stanley, Lehman Brothers and City stalwart J.P. Morgan Cazenove.
PM:
A Harbinger official didn’t return calls seeking comment. Merrill officials declined to comment. An Inmarsat spokesman said company Chief Executive Andrew Sukawaty met with Harbinger officials last month, the first such meeting since Harbinger bought the stake, but that the subject of a takeover didn’t come up.
PM:
That’s from the Journal’s new Letter from the City column
PM:
Just to give the competition a puff
NH:
it seems a lot of people missed it this morning because of the headline
NH:
but it basically confirms what we have been saying
NH:
and I note one broker this morning
NH:
has been telling clients to sell ISAT
NH:
on the grounds the bid spec is flakey
NH:
Returns under threat: Returns are at risk from increasing competitive pressure on voice pricing, together with growing competition from MSS and also VSAT operators in data. Our analysis suggests that each 1 percentage point reduction in margin reduces our DCF valuation by 3 percentage points.
NH:
Significant additional risks: We see three further risks to the business case: 1) The launch of a new Inmarsat4-f3 satellite (already delayed from April); 2) The successful introduction and uptake of new products; and 3) USD as the reporting currency but 60% of operating costs in GBP means that currency risk is a further complication.
NH:
M&A speculation overplayed: Bid speculation has been a key driver of recent share price outperformance. We think this has been overplayed and do not see stake building by Harbert Fund Advisors as a precursor to a full bid.
NH:
Low visibility on near-term option value crystallisation: Visibility on a partner being found for ATC is low. Furthermore, the in-flight mobile market will, at best, only begin to become financially material in 2009.
NH:
Valuation stretched: A 10.9x EV/EBITDA 2009E multiple represents a rating more than double the UK sector average and a significant premium to European satellite peers. With fundamental value on the existing business identified at 410p, we initiate coverage with a SELL recommendation.
NH:
Blue Oar view: Inmarsat shares have inherent optionality from ATC spectrum and in-flight mobile. However, the current rating leaves no margin for disappointment with the existing business, where we see returns under threat. Visibility on near-term catalysts to crystallise option value is low. The existing business will therefore remain the key area of investor focus. With fundamental value on the existing business identified at 410p, we initiate with a SELL.
NH:
ISAT shares currently up 13.5p at 508.5p
PM:
Surprised there’s been no statement on this one yet
NH:
crikey. have you seen Badger Bank??
PM:
It was self-inflicted Neil!
PM:
Pushed into the indicative auction
NH:
actually Bruce Packard has done a model on Badger Bank
NH:
and u can play around with the assumptions
NH:
seen the housebuilders this morning??
NH:
taken another battering
Bellway (BWY:LSE): Last: 392.75, down 27 (-6.43%), High: 426.25, Low: 386.25, Volume: 553.23k
Persimmon (PSN:LSE): Last: 226.00, down 10 (-4.24%), High: 235.75, Low: 217.25, Volume: 2.78m
Taylor Wimpey (TW:LSE): Last: 30.75, down 1 (-3.15%), High: 33.00, Low: 30.00, Volume: 3.32m
Barratt Developments (BDEV:LSE): Last: 41.25, down 1 (-2.37%), High: 44.00, Low: 40.00, Volume: 5.42m
Redrow (RDW:LSE): Last: 99.75, down 10.75 (-9.73%), High: 109.00, Low: 95.75, Volume: 323.68k
Bovis Homes Group (BVS:LSE): Last: 309.50, down 9 (-2.83%), High: 318.50, Low: 303.25, Volume: 864.18k
NH:
now, this is a big week for the housebuilding sector
NH:
there are updates from BDEV, Persimmon, and Redow
NH:
and it will tell us just how grim things are
NH:
and crucially we will get to hear more on land write downs
NH:
ahead of all that, Merrill Lynch has published a real gloomy note on the sector
PM:
yes, Sam put it up on the site earlier
PM:
some big downgrades in there
PM:
perhaps the most eye-catching is on BDEV
NH:
yep, how bearish is that?
NH:
just been looking at the note in a bit more depth
NH:
the analyst Mark Hake is pretty highly rated
NH:
he did that note a while back where he visited about 50 housing sites in four days
NH:
and came back and told clients to sell everything
PM:
What is he saying now?
NH:
well, he has been looking at last week’s statement from TW
NH:
to recap it took a writedown of £600m
NH:
the equivalent of 11% of its land and work in progress
NH:
Hake believes this will just be the start of the write downs
NH:
and the scary thing is, he reckon TW might be forced to take further hits
NH:
especially if this hit proves to be as bad as the 90’s
NH:
especially if the banks continue to ration mortgage lending
NH:
right, here is the note
NH:
Taylor Wimpey starts the ball rolling
Taylor Wimpey’s confirmation that it is intending to writedown some £660m,
equivalent to about 11% of December 2007 Group land and work in progress
(WIP), marks the likely start of a prolonged process of NAV adjustment across
industry players. Note too that this writedown is after a c£280m provision taken by
the group against its US land assets in 2007.
NH:
Capital raising required but may prove hard to deliver
Despite claimed extensive support from its shareholders and bankers neither
Taylor Wimpey nor Barratt has yet to complete any short term re-financing or
capital raising exercise. We remain of the view that such deals will eventually be
struck but will have a massively dilutive impact on NAVs on a per share basis.
NH:
Covenants rolling over
In addition, as part of such a re-financing, we take the view that a re-negotiation of
covenants would be a necessary concession by the industry’s principal lenders
and while we believe that they are disinclined to pursue the “debt for equity swap”
route at this stage, equally, we suspect that they would be willing to provide
additional headroom to the housebuilders for a limited time-frame.
NH:
But once is never enough
We reiterate our view that if the industry’s 1990s experience is repeated then one
round of write-downs will be inadequate, and against a backdrop of falling house
prices we anticipate that both Taylor Wimpey and the wider industry will need to
re-visit land values on a regular basis over the next 18-24 months.
NH:
Kier opinion upgrade
Having initiated in January with a Sell/Underperform when the stock was 1334p,
we feel that at current levels, and given that UK housebuilding accounts for no
more than 35% of EBIT, recent underperformance discounts pretty much all of
the likely mid term negative newsflow from the group. Hence, we raise our opinion
from Underperform to Neutral.
NH:
Lowered price targets
We pull back our price targets on 8 of the 9 housebuilders under coverage, as
summarised in the Table, right. Only Galliford Try is left unchanged. For 6 of
these changes, our new price targets correspond to NAVs post a combination of
an assumed writedown to land and WIP, in line with the 1990s sector average
and also assume a 2 for 1 placing issue. For Berkeley our revised price target
corresponds to stated NAV; and for Kier, our price target is derived by DCF
NH:
The write-downs begin
In the wake of Taylor Woodrow’s first steps towards recognising falling
land values on its balance sheet, and ahead of what we suspect will be
similar pronouncements elsewhere in the sector in the coming weeks and
months, we have decided to adjust our price targets on 8 of the 9 UK
housebuilders under coverage to reflect the potential impact of writedowns
in landbank and WIP, as well as possible (or likely in some instances)
capital raising exercises.
Reminder to readers – if you arrived late and want to stop the dialogue ‘jumping’ as you catch up, hit the ‘pause auto-scrolling’ tab at the bottom right hand corner
NH:
To this end we undertake a theoretical re-valuation exercise, in which our key
assumptions are summarised below and principal conclusions outlined in the
subsequent table.
To begin with, we would note that Taylor Wimpey’s proposed land writedowns
give us some directional and methodical indication of this exercise and its knockon
implications for sector NAVs.
NH:
At the same time, the delay in announcing what appeared to be a “done deal” in
terms of the refinancing, and its proposed scale, give us some idea of the
potential capital raising capability of the UK housebuilders.
The Table below summarises how we have derived our price targets for the 7
“pure” housebuilders in our coverage universe. Broadly, we have assumed that all
of them, with the exception of Berkeley (see below) will need to both take
landbank writedowns as well as undertake some kind of re-capitalisation.
We can look at these six apart from Berkeley as comprising the “distressed duo”
of Barratt and Taylor Wimpey, and the robust quartet of Bellway, Bovis,
Persimmon and Redrow.
NH:
For this quartet we have decided to apply a 30% writedown to both Land and WIP
for two reasons: First, that as we have previously reported, this was the scale of
average provisions in the early 1990s housing recession; and second, that Taylor
Wimpeys’ reported 7-8% drop in ytd house selling prices confirms in our mind the
clear negative momentum that has taken hold in the wider housing marketplace.
NH:
Taylor Wimpey, which we believe to be the most distressed housebuilder (given
its land creditor and pension fund liabilities in addition to straightforward bank
debt), we assume a 50% land writedown (but 30% for WIP) and a capital raising
exercise only being deliverable at a 50% discount to the share price.
NH:
For Barratt, we also anticipate that any capital raising would have to be
undertaken at a 50% discount to the prevailing share price, but we do not believe
at this stage that land writedowns need to be as severe as at Taylor Wimpey- and
assume a 40% land writedown, and 30% for WIP. The lower percentage land
writedown versus Taylor Wimpey reflects our view that strategic land brought to
the group with last years’ Wilson Bowden acquisition should help cushion the
requirement for provisions in the short term.
NH:
and here are Mr Hake’s thoughts on house prices
NH:
UK House prices
We would reiterate that our underlying macro assumption behind our forecasts is
for UK house prices to fall by up to 17% between 2008-09. We remain
comfortable with this view but would highlight that expectations for UK house
prices have moved sharply lower over the last month.
NH:
The Halifax index (nonseasonally adjusted as used by the derivatives market) is now down 7.3% from the August 2007 peak. Property derivative mid-pricing indicates a further 27% decline over the next three years. 18% decline is expected over the next year (May 2008 to May 2009) followed by a further 8.5% decline in year 2 and
2.7%decline in year three.
If this decline is realised, UK house prices would have
fallen 32% from their peak. This would result in house prices in 3 years time
returning to a similar level to September 2003.
NH:
The charts below compare the decline with the 1990 correction – even in real
terms it looks significantly worse, with house prices falling faster and further and
very little recovery in real terms expected over 20 years. 10 year mid forwards
are quoted at 105% – hence house prices are expected to be below their August
2007 peak in a further 10 years time (May 2018)
NH:
so prices could head back to the level on Sept 2003
NH:
and Hake is not the only one writing some deeply pessimistic about the housebuilders this morning
NH:
So is Royal Bank of Scotland
NH:
or the artist formerly know as ABN Amro
NH:
they have finally rebranded ABN Amro
NH:
and instead of the green and gold notes we used to get
NH:
it is all blue and white
NH:
and the top line is this
NH:
A severe volume and price correction now looks largely inevitable for the UK
housebuilders. With land values likely to adjust down sharply and the pace of cash
generation restricted, we see no reason to alter our cautious sector view
NH:
which doesn’t leave much room for doubt does it?
NH:
note is written by John Messenger
NH:
who was asking all sorts of probing questions on the TW conference call last week
NH:
anyway, here is the executive summary from the note
NH:
Increased trading pressures lead to large forecast cuts
With mortgage approvals at record lows and the pace of house price decline far steeper than in previous downturns, a severe market correction now appears likely.
NH:
The dual pressure of sharply lower volumes and an estimated 20% nominal house price fall over two years prompts us to make
significant downward sector EPS adjustments – by an average of 90% for FY09F and 91% for FY10F. While EBIT margins should remain in positive territory (helped by cost savings), significant
financing charges are likely to drive several companies to near breakeven, and two (Barratt and TW) into loss, in our view. Our dividend forecasts have been either cut sharply or removed
NH:
Cash, covenants and writedowns
Investor focus, however, has moved from earnings to cashflow and assets. After peaking in mid- 2008, we see net debt being eroded across the board as discretionary land investment is halted, but land creditor payback, contracted land spend and significant volume uncertainty are likely to hamper the pace of cash generation.
NH:
Asset writedowns have begun, but the management discretion involved in this process is likely to lead to significant inter-company variations, and we prefer to focus on the likely economic change in asset values, with our view that a 20% house
price decline could knock 70% off land values. With EBIT declining, indebtedness still high and asset impairments underway, several players are likely to breach banking covenants, adding another layer of complexity to the equity story.
NH:
Valuation – a focus on economic NAV and build-out DCF
Continuing the themes of our recent notes (’A difficult year in store’, 8 January and ’Pressures intensifying’, 8 May), our valuation focus remains on economic NAV (adjusting NAV for changes in market land values) and build-out values (landbank DCF wind-down).
NH:
The former suggests that the 70% potential land price adjustment is not yet factored into several share prices, while the latter implies that much of the remaining landbank cashflow belongs to debtholders, land creditors and other stakeholders – primarily the company pension fund. With this in mind, we see little reason to alter our cautious sector view, with Barratt, Persimmon and Taylor Wimpey rated at Sell.
NH:
much of the landbank cashflows belongs to the banks
NH:
in the case of TW and BDEV
NH:
I reckon the banks now control both companies
NH:
the equity is pretty much worthless
PM:
We are getting fresh calls on this – live
NH:
yep, it appears things have moved on from just advisers being appointed
PM:
We believe this deal is pretty close to going live
NH:
it seems there were discussions between the two parties last week
NH:
now, we are not sure if a full panel tripping offer has been made
NH:
but certainly the rough outline of a proposal has gone in
PM:
Yep – this situation is no longer RAW
NH:
of course, as Harbinger already controls 29%
NH:
I can’t see that they will offer a huge premium
NH:
and perhaps this is where things we get difficult
NH:
the other big shareholder in this is Peter Davis at Lansdowne
NH:
I know they think a lof of this company
NH:
and won’t sell out on the cheap
PM:
Stock price update — trading at 518, up 23.5p
NH:
now hearing there was a face to face meetinig between Isat and their advisers and Harbinger’s advisers last Thursday
PM:
Should do some Marks & Sparks before we finish off
NH:
share price on the slide again
NH:
and the timing could not be worse for Chairman Rose
NH:
the People’s Rubplic of Marks & Spencer has its AGM on Weds
NH:
shareholders palnning a protest vote against the Chairman
NH:
who is nonetheless expected to prevail
PM:
Neil — your spelling is worse than mine!
NH:
sorry typing and surfing and checking email all at the same time
NH:
down 8.75p at 218.25p
PM:
Close to 200p — half the Green inidicative bid price
PM:
This stock was once at 700p
PM:
So why hammered tho??
NH:
well, I will give you my theory on it
NH:
I think we are witnessing here is M&S losing its premium rating
NH:
to the rest of the retailers
NH:
people are saying, why should M&S not be rated on the same multiple as Next
NH:
around 7 times prospective earnings
NH:
after all, its food business is a mess
NH:
the asset backing argument is out of favour
NH:
and anyway prices are falling and 40% of the property is pledged to the pension fund
NH:
on top of that M&S has got quite a bit of debt
NH:
it geared up after the Green bid
NH:
launched a big share buyback programme
NH:
which seems to have been a colossal waste of money
NH:
that said, Next has done the same
NH:
and to top it all off there are real concerns that the dividend will have to be cut
NH:
the company says no it won’t
NH:
now, no blue chip stocks yields 10% for long
NH:
and as we saw with the banks, why should investors believe anything managements say about divi payments??
NH:
they can’t forecast how bad the downturn will be
NH:
and if the economy keeps slowing the divi will be cut
PM:
and we should also point out here that on Friday, Citigroup, which is M&S’s joint broker, downgraded to sell and set a 205p price target
NH:
but if you want an even equally bearish take
NH:
you should look at the note put out by Tony Shiret at Credit Suisse last week
NH:
and hat tip to Mr Shiret coz he has called the downturn in the M&S price
NH:
We are retaining our Underperform rating and we have reduced our
target price by 34% to 210p. We believe that the debate here is moving on
from how deep and long will the downturn be and how should this cyclicality
be reflected in the M&S valuation to how should we additionally anticipate
the possibility of management change and its effect on the re-basing of profit.
NH:
We reproduce below our post conference call thoughts on M&S. We now think in broad terms that strategy as expressed by management is unsustainable and what is in issue is the pathway and cost of moving to a new strategy. An example of the type of cost involved might be the cost of re-positioning the food product offer, which would we believe result in a margin hit, or the cost of establishing a direct sourcing operation for clothing of more meaningful size than the current one. Clearly these are not strategies currently being considered by M&S management and as such we would expect that there is a strong possibility that management changes may have to be made here.
NH:
We have also set out revised profit estimates. We regard these as continuing vulnerable to downgrade in the short term and only as indicative after the short term in that new strategies may well have been developed over this longer time frame and these can clearly not be incorporated at his stage. But as we say we would expect there to be a cost to new strategy – so 2009/10 may well still be optimistic.
On valuation until we can evaluate new strategy we prefer to run with a dividend based valuation. But our forecasts now incorporate a 50% cut to dividend to establish more sustainable cover levels. We believe that the dividend should be valued around a 5% yield implying a share price target subject to the provisos above in the range 200-220p.
NH:
We think that this will be seen as a key day in the history of M&S. Regrettably we feel that the credibility of senior management has been irreparably damaged by both the degree of profit erosion in what was meant to be a relatively defensive company since Christmas and the lack of any clear idea from management that they have a grip of problems in either part of the business.
The promotion of Stuart Rose’s former PA to Head of Food and the removal of Steve Esom, one of the best food retailers of the past 10 years, 3 months after
appointing him to the Executive Board, highlight the disarray of management in our view.
NH:
Consequently we feel that there are two ways of looking at M&S now. One can take the view that we should look at how the strategies as set out work through against current market backdrop and outlook. Alternatively we need to consider how a management change would happen, consequences for strategy and profit and how to reflect this in valuation.
Looking at the fundamentals within the existing strategic framework we have been
surprised that the company felt the need to warn so early in the year and we expect a
further material downgrade to consensus estimates towards the tail-end of the first phase of the Autumn/Winter 2008 clothing season.
NH:
and while we are on Marks
NH:
Nick Bubb at Pali has also downgraded
NH:
The shares are now already within touching distance of our recently revised 220p target, but.
Having re-examined our model, we are cutting our profit forecasts further, from £750m to £700m PBT (31.4p) for 08/9 and from £650m to £590m (26.3p) for 09/10.
This assumes increasing gross margin pressure, particularly in Food, on top of the sales and cost pressure (and no more share buybacks).
NH:
On this basis, dividend cover is pretty thin for 09/10 (at 1.2x) and though the current management team seem inclined to tough it out and hold the dividend at 22.5p for this year, there may very well be a new management team in place by this time next year and we think a more prudent attitude will prevail. With net debt likely to rise to over £3.7bn at March 2010, we forecast a 20/25% cut to 17.5p in the 09/10 divi.
As far as the key AGM re-election vote on Wednesday is concerned, Stuart Rose seems likely to survive, but with such a sufficiently embarrassing 20-30% protest vote that his authority will be much weakened.
NH:
Since the downgrade process began in M&S two weeks ago, on the back of the recent Nielsen monthly Food market share figures, our 08/9 profit forecast has come down by 20% and our 09/10 forecast by 30%, so with the shares “only” down by 33% last week after the profit warning, it is arguable that the shares/PE haven’t yet been punished enough
At 227p, the shares are trading on a PE of just over 8.5x for 09/10 and yield 10% and we think that valuation can come down further, towards Next (6.3x PE at 873p), notwithstanding the (fading) benefit of £3.5/4bn of freehold property.
We are cutting our target from 220p to 195p (a yield of 9% on our reduced divided forecast and PE of c7.5x for next year).
NH:
before we go, there was a post earlier on Tanfield
NH:
and we do have a bit of comment
NH:
in spite of some really negative press comment at the weekend
NH:
stock has rallied this morning
NH:
and that follows a statement
NH:
that in true Tanfield style came out well after the market closed on Friday night
NH:
said Tanfield’s US division – Snorkel – had managed to extend its banking facilities
NH:
now Snorkel is largely responsible for Tanfield’s woes
NH:
was acquired last year
NH:
and it has proved to be a total disaster
NH:
anyway, here is a quick bit of comment from Mike Stoddart at Daniel Stewart
NH:
The company made an announcement on Friday:
New Bank Facility “The Company announces that its wholly owned subsidiary, Snorkel International Inc., has agreed a five year revolving credit facility of up to $35 million with JP Morgan Chase Bank NA (‘Chase’) secured over Snorkel’s assets. The facility will bear an interest rate of the greater of prime rate of interest announced by Chase and the Federal Fund’s effective rate plus 0.5 per cent., subject to a cap of 5.25 per cent and a floor of 3.67 per cent.”
NH:
There may be some relief today that Tanfield has been able to secure a credit facility. It had repaid all its debt (except about £1.7m of finance leases and £81,000 of invoice discounting) with the proceeds of the share issue that was done to pay for Snorkel in mid-2007. If the group can halt its cash outflows, then this facility may give them sufficient time to be able to stabilise its finances and survive the downturn in sales of powered access equipment. To put the amount in context, $35m is about the same as the cash outflow that the group suffered in H1 2008. Hopefully, the cash outflows should slow down from now because of the reduction in the need for working capital
NH:
There were also press reports over the weekend that PWC is being brought in to “verify the accounts” and “check the working capital assumptions”. It is difficult to know whether to be worried or relieved over this news. Our biggest concern would be that PWC would find that not all of the amounts which had been ascribed to working capital should have been. This could lead to a restatement of the accounts and a further collapse in confidence (if it can get any lower). As far as we can see there has been no official notification of their appointment or the reason for it – which, once again, is an example of poor communications.
NH:
We would still sell Tanfield. Until the group can demonstrate that it has reversed its cash outflows we could not recommend the shares except on a speculative basis.
NH:
and for anyone wanting more on Tanfield
NH:
excellent piece in the Sunday Tel this weekend
PM:
thank you for joining — and thanks for al lthe comments
NH:
Inmarsat plc notes recent press speculation regarding the intentions of Harbinger Capital Partners (“Harbinger”). The Company confirms it has received a very preliminary approach made on behalf of funds managed by Harbinger which may or may not lead to an offer being made for the Company. Discussions between the parties are at a very early stage and there can be no certainty that any offer will ultimately be made for Inmarsat or as to the terms of any such offer.
NH:
and you know where you read it first
PM:
So we should say a special hello and thanks to our readers at the Panel on Takeovers & Mergers
PM:
Kind comments below. Should not let it go to our heads
NH:
the Journal were on the case as well
PM:
back tomorrow at 11am
NH:
hearing the mooted offer price is a fraction over 600p
PM:
But that bit remains RAW
NH:
stock in auction at the moment
NH:
looks like it will unwind at 540p
