Markets Now - Friday 22nd May 2020

In these tumultuous times we should cling onto the certainties we have. One such source of comfort is that Aim-listed oil punts will always, always disappoint. So it transpires with Hurricane Energy, whose fractured basement prospect off the coast of the Shetlands is misfiring.

Hurricane warned that interference between its two producing wells at the Lancaster prospect made a target sustainable production rate of 20k barrels per day impossible. One well has been shut down. The other is pushing out 10.3k barrels per day, meaning long-term forward guidance of net 18k barrels and full year guidance of net 17kb barrels are withdrawn. Bad news. Here’s Morgan Stanley:

We believe that today’s announcement significantly increases uncertainty regarding the reserves that can be recovered by the Lancaster EPS over the course of 6-10 years without any incremental capex. It also materially increases the probability of well-intervention work at the 7z well or the drilling of an additional well for Lancaster EPS, both of which would require incremental capex. Finally, with the company reiterating its FY20 production guidance at the CMD on 27 April, we believe today’s announcement of suspending the production guidance will not be well received by the market.

And Barclays:

By reverting to single-well production at Lancaster for the foreseeable future Hurricane may have turned a cash-generative data-gathering process into a data-gathering process at current oil prices. With capital spending already reined in to conserve cash ahead of the July 2022 bond maturity, Hurricane appears to us to have limited flexibility to accommodate the impact that a substantially reduced production outlook could have on its cash flows.

Achieving a sustainable rate of up to 20kb/d from two wells at the Lancaster EPS has not been possible due to interference between the wells. Rising water production (an existing concern for investors) does not appear to have been the issue. Hurricane have elected to shut-in the -7Z well and produce only from the -6 well.

·      The -6 well is currently producing 10.3kb/d and management plan to gradually increase this to establish the maximum sustainable level from the single well configuration. There is no guidance on what this level could be or how long the process could take. However, FY20 guidance of 17kb/d is suspended.

·      Further updates will outline the new plateau production rate based on single well production, which we would expect to have a negative impact on both guidance of 18kb/d for future years and 2P reserves of ~34mmboe.

·      Quantifying the potential cash flow impact requires assumptions about what the new long-term production rate from one well can be. The chart below shows the impact on cash flow from operations at a stable rate of 12kb/d (a 33% cut) from H2/20 onwards, assuming a flat Brent price of $35/bbl. In this 12kboe/d scenario we do not believe Hurricane would be free cash flow positive at $35/bbl, meaning it would need to secure new capital to repay the $230m bond due in July 2022.

Is it really that bad though? Maybe not, says RBC Capital Markets:

[T]he market has responded negatively to what appears to be a well issue, rather than a reservoir issue. We have cut our Price Target to 25p (30p) to reflect the impact of reduced 2020-21 cash flows and increased uncertainty. However, remedial actions need to be considered before we revise our business case. ...

Pre-production, management expected that the two wells would deliver 20,000b/d with the assistance of electrical submersible pumps (ESP) and a contribution from the full 1km borehole in each well. In Q1/20 management celebrated achieving 20,000b/d without the use of ESPs, while noting that only the foremost 60m of the wellbores were contributing. We believe that management’s immediate obligations are to assess the impact of switching on the installed ESPs and, depending upon the results, recompleting 7Z so that it produces from a larger, more distant, portion of the wellbore. A recompletion might also enable Hurricane to address the well’s water-production issues.

Timing: Even working within the constraints of Covid-19, the ESPs could be commissioned relatively quickly; indeed, a well recompletion could probably be undertaken in H2/20. We believe that these options need to be exhausted before we revise our outlook for the business and investment case.

Today’s production update has had a negative impact upon our 2020-21 revenue and cash flow forecasts, and this has resulted in a reduction in our core NAV to 7p/share, from 17p/share. In addition, we have increased the risk associated with follow-on development phases on Lancaster; the net result is a reduction in our Tangible NAV to 26p/share, from 33p/share.

AJ Bell, which is like Hargreaves Lansdown but much smaller and with wildly overwrought adverts, is leading the FTSE 250 fallers at pixel. Invesco has sold nearly all its holding for £124m or thereabouts.

The sale (at 400p apiece, a 10 per cent discount to Thursday’s close) will of course be difficult to untangle from last week’s departure of fund manager Mark Barnett, who had AJ Bell in his Income and High Income funds. Other stocks were Mr Barnett’s funds are a lumpy shareholder include Puretech Health, Derwent London and Breedon so it might be worth keeping those in mind for overhang risk.

In sellside, Goldman’s gone to “buy” on ITV in a big European broadcasting sector note:

What have we learned from 1Q20 results? 1Q20 results came out better than feared across the European broadcasters (17% average EBITA beat vs GSe), driven by slightly better TV advertising performance (average NAR growth of -7.2% vs. GSe -7.6% and consensus -8%) and lower programming costs. The outlook for April was weak (as expected) given the greater impact from COVID-19, but also reveals a large dispersion in ad trends by market, with Germany and the UK outperforming at -40%, Spain -50% and France the worst at -60%. While visibility remains limited, several companies suggested that trends in May would be in line or slightly better than April with the exception of the UK, which we expect to trough only in May given the extended lockdown.

Where to from here? As COVID-19 restrictions ease and activity begins to gradually reopen, we forecast NAR growth to improve across the sector from -41% in 2Q to -22% in 3Q. With broadcasters being the worst performing subsector YTD (down 41% on average vs. STOXX 600 Media down 27%) and de-rating 14% (on consensus 2021E P/E), the improved ad momentum could support share prices in the near term, in our view. However, overall we expect the crisis will only accelerate the secular shift in advertising budgets towards digital, while potentially also leading to more attempts by the EU Broadcasters to seek further partnerships and M&A to share costs and build scale.

ITV up to Buy (from Neutral) given recent underperformance: As we approach a potential inflection in TV advertising momentum, we see ITV as attractive, noting that the stock is down 51% YTD vs. peers 41% and de-rating 35% vs peers’ 14%, despite better underlying trends and higher exposure to Studios which should see a strong recovery in 2021, in our view.

Unpacking a Pro7 SOTP value; stay Neutral: ProSieben’s share price is up 60% since the March 26 announcement of a strategic refocus and management reshuffle, which we believe was driven by hopes of value crystallisation and de-leveraging. We refresh our SOTP analysis with greater granularity on the various assets within the Content and Commerce portfolios, and estimate an €11.3 valuation, which we now use as the basis for our fundamental value in our target price. However, with 11% potential upside to our revised target price, we believe the potential for value crystallisation is largely priced in, and we retain our Neutral rating.

G4S and Securitas are on “overweight” ratings at JP Morgan Cazenove as part of a thing on the European security services companies:

Following a period of being Not Rated, we reinstate our recommendation at OW with a revised PT of 110p (Neutral, 225p prior to restriction), reflecting potential for the stock to close some of the gap vs. the market, with 20% upside potential to our PT. We also double-upgrade Securitas from UW to OW with a PT of SEK130.

We forecast LSD organic revenue declines in 2020 and despite higher costs (sick pay, PPE) our 2021 profit is largely back to 2019 levels. Securitas has no covenants while we see c.0.5x headroom to G4S’ covenant at Dec. Securitas could restart its DPS and M&A in 2020. Earnings valuations are at lows vs. the market.

Top line: defensive & seeing additional demand. The security companies are defensive into a slowdown (Securitas -1%/+1% in 2009/10, G4S Secure Solutions +3.5%/+2.8%) and generally late-cycle. We expect organic declines of c.-3% for FY 2020. Both companies saw flat organic growth in March and are benefitting from short-term additional demand, especially in the US (c.30% of sales). Our analysis of job ads suggests Securitas is seeing wide-spread demand while G4S is potentially also benefitting from larger contracts.

Costs: flexible and helped by furloughs, partially offset by extra costs. Margins tend to benefit as the labour market cools off, given lower employee churn and less wage pressure. Currently, wages have gone up at the low end of the pay scale due to health concerns and government programmes skewing incentives, but comments are that higher rates can be passed on. Securitas saw a reduction in its US employee churn in Q1. The companies have made use of ST unemployment schemes, which help reduce the c.30% drop-through we assume.

We include estimates for the costs of higher sick rates, idle time and the costs of PPE on top. We expect costs to remain elevated but consensus reflects that.

Leverage and cash. For G4S, we forecast leverage back up to 2.7x in 2020 (c3x vs. the 3.5x covenant), reducing to 2.3x in 2021 with no divi paid in 2020/21. For Securitas, we forecast 2.7x and 2.3x, respectively (no covenant) with the 2019 paid after all. We assume large receivables outflows, albeit that was not the case in 2009. Payables will be a material help in 2020 due to generous government programmes, to be repaid in 2021/22.

Earnings changes. Today we reduce 2020E/21E EBITA by -9%/-2% (FX +1% for 2021E) for G4S and -13%/-8% (FX -2% for 2021E) for Securitas.

Structural impacts of COVID-19. We believe larger companies will benefit out of COVID-19 and suspect that trend will benefit Securitas and G4S. It will also be interesting to see whether there is higher demand for electronic solutions to minimise human interactions and improve business resilience.

Valuation. Securitas trades on a 2021E P/E of 11x (13x 10Y median) and G4S on 6x (11x 10Y median). They trade at cycle lows vs. the OMX/ASX indices.

And HSBC downgrades Hammerson as part of a big thing on the real estate stocks. It’s all about retrofitting buildings for the new normal. Big pain in the ass, they say:

Although it is still very likely that the tenant appeal, and hence pricing differential between secondary and prime space prevails there is now a further requirement to ensure occupational space is fit-for-purpose in a more socially-distanced and flexible workplace.

The newer stock of buildings developed in this last development cycle (by definition, prime) were designed to be more occupier efficient, with one contributory feature being to reduce average workspace ratios. Landlords face somewhat of a conundrum at present with the nature and intensity of future use still as yet unclear, and an economy sliding into a deep recession that makes balancing spending into a downturn against the urgency to make buildings fit for purpose to underwrite rental income a tricky balancing act. This need to meet the accelerated change in occupier use is likely to cause disruption (and re-basing) in rental cash flows and invite obligatory additional capex to address these demands. In our view, a pressing need to re-purpose buildings suggests the term ‘retrofit’ could be the term most commonly associated with capex over the next few years.

Remain Hold on LAND but cut TP to 573p from 679p. Last week’s Landsec FY20 results confirmed a portfolio decline of 8.8% (GBP1,179m, vs GBP557m in FY19) with the shape of performance as expected. Retail continued its steep decline in value, the Specialist portfolio (Leisure and Hotels) followed while offices held firm. To cap it off, the external valuation of the portfolio (undertaken by CBRE) contained a ‘material uncertainty’ clause in line with RICS guidance. However, these results along with other March year-end companies (and Dec-19 ones) are far less relevant today. ...

Upgrade Big Yellow Group to Buy with unchanged TP of 1096p. Last month’s equity raise highlights a proven and consistent formula to drive EPS growth. The self-storage sector offers a relative ‘safe haven’ within the UK REIT sector with capital value volatility lower than the broader REIT sector, and the risk from operating disruption lower than many other sub-sectors. BYG still has all facilities open.

Downgrade Hammerson to Reduce and cut TP to 52p from 83p. HMSO’s equity is now trading at an 88% p/book spot discount, based on our estimates indicative of a potentially highly dilutive capital raise following the failed closure of the GBP395m retail park portfolio sale to Orion European Real Estate Fund V.

4.30pm BST - Before we knock off for the week a quick line on Marston’s brewing joint venture with Carlsberg’s UK lager division. It’s a 40/60 split in favour of the Danish. Marston’s has nearly doubled in response as an effective sale of its brewery (with some control retained) helps dig it out of a liquidity k-hole.

The important details are that Marston’s Brewing gets a value at up to £580m (13.0x adjusted 2019 Ebitda) and Carlsberg UK Brewing is valued at £200m (9.5x adjusted). Marston's gets equalisation payment of up to £273m, including £34m of contingent deferred payment, which will cut its net debt from 6.3 times Ebitda to less than 5. There are cost savings and stuff too, as set out by the statement. Here’s Stifel:

Our first take is that this deal looks strategically sensible in a brewing industry where it increasingly pays to have scale (cf. Fuller's/Asahi 2019), and is financially attractive, providing a neat solution to a looming capital structure problem given that Marston's leverage had become unsustainably high and raising equity was arguably off the table. Very crudely, Marston's share of synergies capitalised at 10x could be worth ~15p/share plus some re-rating from allayed leverage concerns and the initial share price move to ~60p seems a reasonable opening gambit. Discussions were initiated pre-COVID so this does not look like a shotgun marriage to us. Completion expected in Q3.

Scale matters. The brewing industry has become increasingly polarised between the very big and the very small (micro brewers) given scale efficiencies in production, distribution and marketing. Carlsberg and Marston's are the #5 and #6 in the UK with £430m and £378m sales respectively compared to £1.6bn at ABInBev

Marston's ale-led portfolio (9.6% UK market share, 13.4% combined) is complementary to Carlsberg's lager-led offer (12.9% UK market share, 14.4% combined)

Marston’s to focus on its pub business while retaining a 40% interest in a larger, more attractive brewing business.

• Updates to follow, which’ll be guided by requests and complaints in the comment box. A Telegram Markets Live chat group is also available.