Markets Now - Tuesday 9th June 2020

An early paper published by the Rand Corporation is The Prediction of Social and Technological Events (1949). It’s among the first serious kickarounds of the whole wisdom of crowds versus soothsayers thing.

Its authors conclude (as many studies since have also concluded) that opinion polls tend to be better at predicting the future than experts. More interesting perhaps is its analytical work towards a conclusion that the experts are full of crap. Efforts to measure their accuracy proved impossible and were abandoned because too many predictions were constructed out of equivocations, ambiguous assertions and vapid banalities that were floating untethered within time and space.

You probably noticed that Monday’s return to flat year-to-date for the S&P 500 has triggered a lot of huffing about how a Day of Reckoning is approaching. You know the kind of thing. There’s only so long we can be distracted by the money printers and eternal zirp. The rally’s built on a lack of alternatives to equity now that we’re travelling without a risk-free rate. Fundamentals must matter again sometime, right? There will be a day when we need to stop flying on fumes. Well, those Cassandras will be feeling pretty pleased with their predictive powers today because . . . 

Needless to say, there’s a big, expensive difference between saying the market will fall and saying it will fall tomorrow, particularly when crowd wisdom has just done a 40 per cent return in slightly over two months. If it’s your job to look right then it’s best to stay as vague as possible, with something along the lines of: “We predict consolidation in the near term, but remain bullish long term.” Nothing much has changed since 1949.

Changing the subject, here’s the latest from Credit Suisse:

We raise our year-end target slightly to 281 for MSCI ex US (3% upside) and expect markets to move sideways in the near term; however, we would look to buy into any weakness, with an end-2021 target of 299 (9.6% upside). We are strategically overweight equities.

What are the near-term concerns?

i) biggest decoupling between earnings revisions and market performance since 1998; ii) credit spreads now appear fair (and equity and credit have been very closely correlated); iii) recent rise in bond yields.

What are the tactical supports?

i) tactical indicators are very low given the rally in the market (especially bullish sentiment and net speculative longs); and ii) on past occasions when markets have rallied 43% from their low, they have been up on a 6-month view on six out of seven occasions (on average by 5.2%).

What are the fundamental supports?

• More of a V-shaped recovery, based on policy: We expect open-ended fiscal QE outside the Eurozone to continue until unemployment falls to politically acceptable levels. We think that the case mortality rate for under-60s (without comorbidities) is sufficiently low that we should not see widespread second lockdowns, especially as treatment and testing improve. Case counts have risen only modestly for the early openers.

• Equity Risk Premium – the key support for equities: On our EPS numbers (below consensus), the ERP is 6.4% compared with a long-run average of 5.4%. On our warranted ERP, driven by credit spreads and ISM, we are now close to fair value, but on end-21 projections see a fair value of c3500. We see fair value 12m forward P/E of 21x (if the TIPS yield falls to -2%).

• Excess liquidity remains highly supportive: Growing at 20%, consistent with a 90% re-rating.

• Dividend futures imply a lot of pessimism: Implied end-21 DPS is 14.5% below pre-virus levels, and significantly worse than consensus earnings estimates at 0.2%. (in Europe, implied DPS is c30.9% below pre-virus levels and EPS 4.2% below pre-virus levels)

• The market ignores trough earnings if policy is right: Markets are the most sensitive to EPS 18 months out; in ’09, equities had rallied nearly 60% before trailing EPS troughed.

• Funds flow to equities relative to bonds has never held up this well (given performance and low bullish sentiment) because: i) bonds risk no longer diversifying, and ii) pension/insurance companies’ equity weightings are low, hence this encourages a bond for equity switch. Additionally, record corporate bond issuance limits corporate net selling.

• Rally broadening: We had the growth to value rotation in ‘03 and ‘09 (very early into the bull market), with the market rising on both occasions, by 23% and 36%, respectively.

... Or maybe you could frame your prediction around some noncommittal Barnum statement. Perhaps something like an advisory to buy growth, quality and defensives.

Unrelatedly, here’s the latest from HSBC:

1. Defense is the best offense

Equities look priced for perfection, and we see a number of downside risks in the 2H of the year which don’t look priced into markets – a relapse in economic weakness, a second wave of COVID-19, US-China tensions, US elections and Brexit. Cyclicals vs defensives have rebounded strongly (in the US up 22% since April) and we see value in defensive sectors – we are overweight Health Care, Telecoms and Utilities.

2. Quality – avoiding the extremes

We like “Quality”, but are cognizant they have a hefty price tag: FY2 PE for companies in the top quintile of quality is 19x. So, stick with quality but avoid the extremes. Companies in the second quintile of our quality framework on average have ND/EBITDA of -0.2 and an ROE of 12% at a more reasonable PE of 15.5x. Cheaper areas of quality can be found in sectors such as Health Care, Telecoms and even the Industrials sector.

3. Growth – worth every penny

Value has beaten growth by 6% since mid-May as PMIs rebound and high yield spreads have compressed. But we doubt such a move is sustainable in the mediumterm. Structurally lower interest rates and economic activity should support growth stocks which are a long duration asset. We remain overweight the Tech sector, which we think will continue to benefit from a number of secular themes.

Anyone wanting reasons for what’s happening today, rather than freeform jazz around the theme of what might happen sometime, has eco. Germany’s posted its first trade deficit since the wall went up. Orders, output, and exports for April all down by the sharpest degrees since data began in 1962. In volume terms, exports and imports fell 23.6 per cent and 14.9 per cent month on month respectively. Does April tell us much about July though? Not really. Here’s JP Morgan:

In the details, exports held up quite well to China, but they fell sharply (by 30-50%oya) to other Euro area countries and to the US. German imports have fallen much less than exports over the past two months, which is also suggestive of German domestic demand holding up better than in partner countries.

Today’s trade report does not affect the upward revision we made to our German GDP forecast yesterday. We continue to think that the economy dropped to 84% of normal during the shutdown weeks, that it started to recover during May and that this recovery looks set to accelerate during June. The report, of course, points to a huge drag from net trade in April, but how exactly the expenditure side of GDP is shaping up in April and in 2Q20 overall is still highly uncertain. As a result, we prefer at this stage to focus on gauging the level of GDP overall and on how the production side of GDP may be evolving. As a result, today’s trade report does not affect this assessment.

Anyway. To profit warnings, and British American Tobacco looks to be in slightly worse shape than some idiot was predicting back in March.

BAT’s revenue and EPS guidance for 2020 goes down 1 to 3 per cent. Constant currency earnings growth guidance moves from high-single digit to mid-single digit; the consensus for the latter had been 7.5 per cent. Emerging markets and vape flutes are the problem areas, with everything else fine. It’s no big drama really, but there’s a bit of a downgrade so it’s an excuse to sell a few. Here’s Morgan Stanley’s summary:

Whilst we expected softer guidance for 2H20, we were surprised by BAT deciding not to accelerate its cost-savings delivery. We think this reflects some of the uncertainty in the business today due to COVID-19 and management retaining the flexibility to manage the earnings algorithm over the medium term.

Key positives: 1) Strong performance in the US (-2% volume growth YTD), with premium market share up 50bps YTD. Global cigarette value share up 20bps YTD, with volume share up over 50bps. 2) Share gain in Vapour and glo back to growth in Japan. 3) We expect 1H20 earnings to be robust driven by lower tax and FX headwinds.

Key negatives: 1) Lowered revenue guidance due to weaker than expected performance in EM and NGP due to COVID-19. 2) Earnings guidance lowered to mid-single digit vs high-single digit earlier. 3) Pace of de-leveraging slowed. 4) NGP £5bn revenue ambition pushed back to 2025 (earlier 2023, later 2023-24 and now 2025).

Guidance update: 1) Volume: BAT expects US industry volume to decline by ~4% vs ~5% earlier. However, it has reduced its expectations for global industry cigarette and THP volume to be down c. 7% (previously c.5%) as a result of COVID-19, most notably in South Africa, Mexico and Argentina. 2) Revenue and earnings: Overall, BAT now expects 1-3% constant currency revenue growth (previously “around the lower end of the 3-5% range”) and mid-single-digit constant currency adjusted diluted EPS growth (previously “high-single figure”). 3) NGP: BAT now anticipates NGP revenues will reach the £5bn target in 2025 (previously 2023/24) due to slow progress in 2020 (MSe £4.7bn in 2025). 4) De-leverage: BAT expects adjusted net debt/adjusted EBITDA to be around 3x by the end of 2021 (previously “below 3x”). 5) FX headwind: At current FX spot rates, BAT expects a translation headwind of around 1% on H1 20 adjusted diluted EPS growth and around 2% for the full year. Further, BAT has confirmed a dividend payout ratio of 65% of adjusted diluted EPS and growth in sterling terms.

And Panmure:

Mid-single digit EPS growth (rather than high) and F/X at -2% would imply an outcome this year of ~330p for adjusted EPS we estimate. Consensus was at ~333p, we believe, and so the “cut” guidance is rather more “shaved”. There is still risk of course: South African authorities seem rather too keen on keeping in place prohibition. But there is also scope to further reduce costs: there are still areas that can be addressed, we are sure. Finessing the estimates arguably misses the point anyway; the PER for the current year is under 10x and under 9x for next year assuming some form of return to normality. There will be dividend growth too, when the list of payers continues to shrink. So there is value and money to be made, but if siren voices look to market rallies there may not be the same to be said of outperformance.

To sellside, and Metro Bank goes down to “sell” at Investec. The upshot is that in spite of everything it remains as close to becoming a functioning metro as a functional bank. Even at 0.2x 2020e tNAV it’s not a bargain when you have to wait for 2024 for any kind of profit, Investec says:

When Metro Bank launched ten years ago in Holborn it embarked on an epic journey to win “fans” and change the face of British banking. This week, as it opens its second store in Cardiff, (store No.76 in the UK), complete with drivethru service, from a customer perspective, the Metro story continues to thrive. It now boasts over 2 million customer accounts. However, the path back to profitability still appears much more problematic, and as such, following a 6- day 54% share price bounce, on 0.2x 2020e tNAV, we cut to Sell (from Buy).

... In essence, although Metro’s “static” capital position was strong at 31 Dec 2019 (CET1 capital ratio 15.6%), it needs to conserve capital to absorb (1) planned investment spend through 2020-23 to “retool” the business, and (2) a LOKIN-20 IFRS9 impairment charge in H1 2020. As such, it has been shrinking the loan book (on a net basis) over the past four quarters and we do not expect it to recommence growth until 2021e.

... Metro is, in its existing format and in the current low interest rate environment, “structurally” loss-making. Its cost of deposits rose sharply during 2019 following the “RWA miscategorisation” debacle which was disclosed in January 2019. In this regard it has, we believe, turned the corner, with three consecutive quarters of net deposit inflows, with marginal deposits once again being sourced through current account and “relationship” deposits rather than relying on expensive fixed term products. However, Metro has yet to rebalance its loan portfolio to enhance yield. It is heavily underweight consumer lending

Premier Oil goes onto Stifel’s buy list. More than 100 per cent upside providing you can see through the impending cash call, they reckon.

On Friday 5th June Premier announced revised terms for the acquisition of two producing North Sea oil & gas assets from BP. The company will now look to raise c.$200M in new equity to complete the deal. There's a near-term trade to go short and cover in the placing, because we think new equity is injected some way below the current level. However on a 12-month view we see substantial upside as the business de-levers, and it offers a good chance of strong returns with an oil price tailwind.

... We expect some combination of a placing and a rights issue. As such, the question for investors now is whether to buy shares in the open market, seek to participate in an equity placing at some point over the summer or take up rights in a rights issue, likely in H2.

... We think new equity is injected some way below the current share price level, setting up a short-term trade to sell the equity and buy back in the placing. While $65/bbl oil offers good fundamental upside, $45 Brent (which is above the current spot price) will slow the pace of deleveraging substantially. The potential for lacklustre returns in this scenario means we'd expect investors to use a conservatively high cost of capital in weighing up the injection of new equity. We look to the ARCM placing price announced Friday 5th June, 27p/shr, as realistic, and see a reasonable strategy as being short the stock into a placing, and looking to cover as new shares are issued.

Equity pricing c.$55/bbl oil long-term, with high sensitivity: The BP acquisition is covenant-accretive and solidly cash generative at any oil price. Long-term oil price expectations of $65+/bbl offer substantial upside, as shown in Figures 3 and 4, and rapid deleveraging.

We see c.$1.1B of equity value (pre-$200M of new equity) at $65/bbl Brent and $1.7B of value at $75/bbl Brent, versus a current market capitalisation of c.$500M. Nevertheless, Premier's overall equity valuation remains highly sensitive to the oil price thanks to the large amount, c.$2B, of current net debt. Even with the new assets we see no equity value at long-term oil prices of $45/bbl or below.

While portfolio-average operating costs are just c.$20/boe, c.$400-500M of annual base capex + cash interest limits FCF available for debt reduction at these levels. On a 12-month view, we believe the stock is a Buy: We remain constructive on oil prices medium term, using a $65/bbl long-term price deck. With the shares pricing $55 oil and corporate actions offering the chance to add a material position likely close to 30p/ shr, we'd look to participate in the upcoming equity issuance.

Flutter and GVC both get downgrades from HSBC in a sector note that’s trend versus fundamentals in microcosm:

Look beyond the accepted wisdom. We think it’s largely right that the gaming sector will enjoy a V-shaped recovery as sporting events resume. But that argument is now well understood, and share prices have reacted accordingly, rallying hard from the COVID-19 market lows. It’s now time, we think, for investors to be more selective: while there are opportunities, we should not ignore other concerns that lie ahead. History shows that a recession is not good for gaming spend and, in the background the European regulatory mood music appears to be getting slightly worse. There’s also the potential threat of higher taxation being levied on the sector as countries seek to repair their debt levels.

The valuation buffer is diminishing. Valuations look full vs. history, even excluding US losses. We screen the risks to valuations through our SOTP prism. On that basis, it’s hard to argue that there’s much room for comfort and this makes us more nervous about the outlook than we were previously. Also, it’s clear to us that markedly different outlooks are being applied to the three groups’ US businesses: GVC and William Hill are ascribed relatively little, while FLTR is given a fulsome long-term value.

Taking a more cautious stance. The sector has rerated from its COVID-19 low prices and it is now time to take a more cautious stance. The operator that still has the most upside is William Hill, in our view (Buy, 230p TP). We think its US business is underappreciated and the European online business is in better shape than commonly perceived. We downgrade GVC to Hold from Buy given the strong recent share price performance as regulatory threats loom in Germany. For Flutter, the performance in the US is impressive, but it’s becoming harder to justify the current valuation given that it faces similar macro headwinds to the wider sector.

Boohoo’s down to “neutral” at Credit Suisse as part of a big “wither retail?” type thing. It has a matrix:

“This time is different” may be over-used in financial analysis (and frequently wrong), but this time, we think the current pandemic is rapidly speeding up many of the trends in Retail and Sporting Goods that were already going to occur. In this report, we analyse each company’s aggregate exposure to six separate trends, reflecting changes in distribution channels and product, the opportunity from peers consolidating, and in particular an accelerating shift from branded retail to “real brands” and multibrand distributors. The total in our matrix below represents growth we would expect from these factors over the next three years.

The online retailers look unsurprisingly best positioned, notably Zalando and Asos, where we increase TPs to €66 (vs €41) and 3,600p (vs 3,300p), respectively. Boohoo scores less well, and we downgrade it to Neutral based on valuation and outperformance.

In sporting goods, we see more changes occurring in distribution (JD Sports and online platforms) than for the brands (Adidas/Puma), where long lead times and low-quality distribution imply a slow recovery.

Surprisingly, we view most apparel retailers as beneficiaries, apart from M&S and Next, owing largely to the expected capacity reduction of 10-20% as failing businesses are finally allowed to fail. Without this recovery, prospects look much more muted.

Forecasts are moving very rapidly. Having cut estimates on several occasions this year for all our stocks, we are increasing earnings forecasts for three in particular (Asos, Zalando and B&M), given the likelihood of recent trading being better-than-expected. We are cutting forecasts for four (H&M, Inditex, Next and JD Sports for FY21), reflecting longer periods under lockdown and greater profit drop-through. Both online demand and more recently trading post-lockdown have surprised, despite social distancing. However, excess promotions, adverse weather and the end of government furlough schemes could all affect demand through the summer.

And Ibstock goes down to “hold” at Canaccord. Valuation mostly. They prefer Forterra:

The recent [Ibstock] trading update confirmed that trading during Q1 2020 was modestly below the prior year and during April volumes in the Clay division fell by -90%, with the Concrete division relatively more resilient given its higher exposure to infrastructure and RM&I. Since the industry started reopening sites and returning to work, it has seen some recovery with brick volumes now down by c.-70% and Concrete down by -50% on the prior year. Q1 2020 Group revenues were down by -10% and down by -75% for the two months of April and May. One-third of sites are now open under new social distancing protocols in response to customer demand and it will restart more manufacturing sites as demand requires. In addition to the already announced measures in response to COVID-19, the group is conducting a review of all its operations. It has announced a restructuring to cut the fixed cost base through selective site closures and cuts to support functions; c.15% of employees are expected to be affected by the restructuring. As at end of May, net debt was c.£105m with significant liquidity and the Group confirms it is eligible for the CCFF scheme.

We adjust our estimates and now expect revenue to fall by c.-30% and Group EBITDA to fall to c.£56m in 2020, before seeing a sharp increase to £86.6m in 2021. Shares are c.+65% above their recent lows and reside on a relatively full EV:EBITDA multiple of c.11.5 times for 2021E on our revised estimates. We tweak our target price to 213p and downgrade to HOLD (from Buy) on valuation after the recent share price bounce.

Forterra gets the same c.30 per cent revenue cut meaning group ebitda falls “to c.£38m in 2020, before seeing a strong increase to £61.5m in 2021. Shares are down by -36% YTD and reside on an EV:EBITDA multiple of c.8 times for 2021E on our revised estimates. We tweak our target price to 241p and retain our BUY rating.”

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