Markets Now - Monday 15th June 2020

Some personal news:

The author, it transpires, has been drafted by the Atlanta Braves, which might appear a quite unlikely turn of events but given the state of the media industry is probably for the best. If any reader understands the rules of baseball or knows where Atlanta is, please get in touch via the usual channels. In the meantime let’s get on with working out my notice period by looking at today’s standings:

The FTSE 100’s rallied a bit from a 2.5 per cent drop early on, which took the index below the psychologically whatever 6k line. In the absence of anything macro we’ve been blaming the virus again, attention having just circled back to China as if we’re playing Monopoly: Plague Edition.

Corporate wise there’s BP, which flags write-offs of between $13bn and $17.5bn post tax after resetting its long-term price guesses to $55 a barrel Brent and $2.90 per mtu Henry Hub. The guidance a few months ago was $70 for the former and $4 for the latter, where long-term means 2021 to 2050. These are the numbers that get fed into BP’s impairment test spreadsheet, both on the physical property side and the exploration intangibles side, so any charge is very much non-cash. It’s all bundled in with a lot of net-zero emissions stuff as the slaughterhouse seeks to rebrand as a petting zoo.

Given what oil’s done is any of this unexpected? No. The only mild negative is that on the numbers given the net debt/equity gearing likely moves from 36.2 per cent at the end of Q1 to just above 40 per cent, which’ll probably force a divi cut at Q2 results, but since Shell’s already cut that’s going to be not too unexpected either. Here’s Barclays:

BP may have surprised on the timing, but the announcement of a new lower price deck and associated impairments has been needed for some time with the company having had the highest assumptions of the peer group. . . . The most notable impact will be on gearing, where every $1bn increases gearing by approximately 0.3%, implying at the top end of the range a 5.3% increase in gearing. Following the announcement of an internal restructuring programme last week, it does now look increasingly likely that BP will reduce the dividend alongside the 2Q results, yet with the shares trading on 10% dividend yield, this already seems to be factored into the share price. Key for the stock will be the re-imaging energy strategy presentation in September where the group will have to prove that it can create shareholder value from an increased focus on low carbon. We rate the shares Overweight with a 380p/sh price target.

And Credit Suisse:

This should add 4-5% points to the gearing ratio on 1Q20 financials, on our estimates. Gearing at the end of 1Q20 stood at ~36% (or ~40% post IFRS-16) vs its target range of 20-23%, and gearing should have worsened in 2Q20 even without these impairment charges due to the sluggish macro environment. BP followed a step by step approach - before unveiling the details of its grand ambition longer term in September, we suspect an update on the dividend will come next. The board reviews the dividend quarterly, and today’s update highlights the company’s more cautious view on the oil macro (and the likely acceleration of the energy transition as we come out of the global pandemic). For example, it stated in the press release that ‘the potential for weaker demand for energy for a sustained period’ and ‘BP’s management also has a growing expectation that the aftermath of the pandemic will accelerate the pace of transition to a lower carbon economy and energy system, as countries seek to build back better so that their economies will be more resilient in the future...’.

In mid-February, soon after Bernard Looney became the CEO of BP, he announced his 2050 ambitions to be ‘net zero’ with details how to get there to be presented in September 2020. This was prior to COVID-19 becoming a global pandemic. In mid-May, BP’s CEO Bernard Looney in an interview with the FT cautioned about the near and long-term oil price outlook stating that COVID-19 may have longer-term implications on oil demand and may accelerate the energy transition, and today he followed through with a firm reassessment. This followed last week’s announcement of a big restructuring plan, in which he announced the plan to reduce the company’s workforce by 15% (with potentially more to follow). All eyes will be on 2Q20 results, where the board will next review its dividend. While these impairment charges may not affect certain credit metrics directly, such as FFO /adj net debt directly, it does make gearing look worse (and much worse than its target range). Gearing stood at ~36% (or ~40% on a post IFRS-16 basis) at the end of 1Q20. This was going to worsen with 2Q20 even prior to the impairment charges. Incorporating these impairment charges (at the mid-point) to 1Q20 would mean gearing would stand at ~40% (or 44-45% on a post IFRS-16 basis), on our estimates. Such impairment charges, however, are unlikely to be unique to BP with other companies, subject to their long-term view on the oil macro, may follow suit. What we have noticed amongst the European majors is that some of them have increased their carbon intensity reduction targets in the midst of the crisis, which suggests that the energy transition may be accelerating.

Much further down the market (though just as predictable) is Cineworld’s decision to back out of the purchase of Cineplex. Cineworld blames “certain breaches” committed by Cineplex without being specific and has reserved the right to seek damages. Cineplex has denied whatever it’s been accused of, said Cineword didn’t make “reasonable best efforts” to get Investment Canada Act approval (among other unspecified failings) and has threatened “prompt” legal action to recover “all damages available to it”.

Absolutely everyone had expected Cineworld to walk before a deal’s long-stop date of June 30 and today, when Investment Canada was due to hand down its ruling on the transaction, was the most obvious point to force the moment to its crisis. It should really be in the price of both stocks. It was certainly in the price of one: Cineplex’s shares ended last week at around C$15 versus Cineworld’s cash offer of C$34.

Predictability hasn’t stopped it being a big ol’ mess though. Here’s Morgan Stanley:

The Cineworld-Cineplex dispute is now set to enter legal channels, widening the range of possible outcomes and creating uncertainty on the timeline. We expect further details on the alleged breaches to come to light during the upcoming legal process. We note that Cineplex accepts the deal will not proceed and is instead seeking damages (which are uncapped under the agreement). We see a widened risk reward: if the legal process finds in favour of Cineworld, it could be awarded damages from Cineplex in addition to exiting the deal. If it finds in favour of Cineplex, Cineworld could be required to pay (uncapped) damages without gaining Cineplex as an asset. A renegotiated deal is also a possible outcome.

We think the termination of the deal will be taken positively in the short-term. On our forecasts, the (debt-funded) Cineplex deal would have raised Cineworld’s net debt by 1.3x in 2021 (6.5x vs 5.2x net debt/EBITDA). In addition, we were cautious on both the Cineplex attendance and profit recovery, and on the scope for Cineworld to extract synergies from an entity coming out of prolonged shut down and cash conservation mode. However, in addition to the legal issues above, which could be prolonged, the deal termination does not change our cautious view on Cineworld.

We value Cineworld as a standalone company (i.e. without Cineplex) and rate the shares Underweight with a 60p price target. While we previously flagged the Cineplex acquisition as a key piece of short-term uncertainty, the termination of the deal does not change our thesis and we remain concerned about how Covid-19 has accelerated structural risks to exhibitors (Premium Video on Demand), diminished the capex-driven bull case, and created uncertainty on the shape of cinema attendance recovery. We would sell into any share price strength on the deal termination given the legal uncertainty and structural issues laid out above.

Peel Hunt (“buy”, target 180p from 140p) also reckons a third-reel reunion scene is the tidiest way out for both sides:

Once tempers have cooled, we believe Cineworld and Cineplex are likely to find a way to merge. . . . 

AMC and Cinemark both commented on the strength of the upcoming slate, noting a mix of sequels and new releases. Marvel will release another film into its popular ‘Cinematic Universe’ with Black Widow, whilst rival DC has a follow-up to the well-received Wonder Women (Wonder Women 1984). Pixar’s Soul and the live-action remake of Disney’s Mulan, both scheduled for release this year, will offer entertainment for younger generations.

Post the AMC news, we are more confident that management will be able to bring the business back to cash flow positive trading post-lockdown. We are increasing our target price to 180p from 140p to reflect this additional confidence. At 180p, the shares would be trading on 8.4x recovered earnings and would be 37% off their 52-week high reached on 17 June 2019.

Over in sellside, Credit Suisse argues for a switch from Diageo to Heineken. The gist is that all types of alcohol are fungible for the purpose of getting drunk and here’s a chart that proves it:

As countries re-open and the macro shock begins to kick in, we switch our subsector preference to Beer over Spirits. We upgrade Heineken to Outperform (from Neutral; new target price €96 from €83), making it our top pick, as we think it is best placed to improve its competitive positioning through the downturn. We downgrade Diageo to Neutral (from Outperform; new TP £29 from £34.50) – we are more concerned about the pace of recovery in Europe and downtrading across its emerging markets.

Five key reasons we prefer Beer over Spirits: 1) Beer is outperforming Spirits across most major markets excluding the US, based on our channel checks and recent industry data points. 2) Premium Beer in emerging markets is now a more credible trade-down alternative to premium Spirits, in particular Scotch. 3) Beer is less exposed to the on-trade and travel retail channels, which will take longer to recover. 4) A weaker dollar environment is more favourable for Beer. 5) Beer stocks have slightly underperformed Spirits since the market correction and present better value at this stage in the cycle.

We think Heineken is well placed to ride out the downturn and strengthen its competitive positioning – i) it over-indexes to the more resilient premium beer segment; ii) our channel checks suggest its share gains are accelerating across key markets Brazil/Vietnam (combined 50% of volume growth in 2018/19) and Europe; and iii) it has the most favourable long-term geographic and category footprint in Beer.

We maintain our long-term view that Diageo should benefit from a strong moat and stepped-up innovation capabilities, however we see less favourable risk/reward over the next 12 months. Although Diageo has the highest exposure to the US, the most resilient market globally, we note: i) it is now losing share in the US, with sales declining; ii) DGE has higher on-trade exposure in Europe, which will be slow to recover, and Spirits is losing share to Beer; and iii) Diageo’s emerging markets are skewed to Scotch, where we see most risk of downtrading.

Jefferies goes postal, with Oesterreichische Post downgraded.

Austrian Post is most exposed to a deteriorating economic environment post Covid-19 in our view, having the highest exposure to advertising mail (28% of revenues, vs. 22% for the sector), which experienced volume pressure of 50% during the lockdown. Covid-19 will likely trigger accelerated e-substitution, with mail volumes per household in Austria still the highest in Europe, 60% above average. Parcel volume growth and pricing is held back by growing competition from Amazon Logistics, illustrated by a 92% surge in Amazon job listings in Austria in 1H20E. There is increased uncertainty around the revenue ramp-up of bank99, with likely fewer people visiting postal service points during the Covid-19 lockdown. We have cut FY20E EBIT by 30% to €135m, after a €40m-€50m adverse Covid-19 impact, and expect the dividend will be cut by 40% to €1.26, based on a stable pay-out ratio, interrupting the growing divided track record. As a result, we think the 38% valuation premium to the sector on FY21E EV/EBIT looks unsustainable, and downgrade to Underperform, with a DCF-based €25.0 PT.

bpost (BPOST BB, Hold) Valuation support ahead of strategy update. bpost is enjoying the strongest domestic parcel volume growth, estimated at 30% for 2Q20E, versus 20% for the sector, while the sales-driven recovery of Radial in the US will likely be supported by SME retailers expanding online offerings during the recent Covid-19 lockdown. We have lowered FY20E EBIT by 9% to €200m, after a 30% cut to €220m last February, after a €55m adverse Covid-19 impact. The valuation has now become more attractive, with a 10% FY21E equity FCF and dividend yield. We upgrade to Hold, with a lowered DCF-based €6.0 PT, ahead of an anticipated strategy update later this year from bpost’s new management team.

Challenging 2Q20E outlook. Postal sector 2Q20E results are due in the first week of August. We anticipate mounting EBIT pressure of 46% for 2Q20E, versus 23% on average in 1Q20. We expect accelerating parcel volume growth of 20% in 2Q20E, on the back of growing e-commerce during the recent Covid-19 lockdowns, will be more than offset by 1). increasing pressure on high-margin letter mail, with mail volume estimated to fall by 17% on average, driven by 50% drop in advertising mail, and 2). cost increases of 5%, related to safety measures and increased absenteeism.

Deutsche Post DHL remains our top-pick in the postal sector. Deutsche Post DHL (DPW GR, Buy) is expected to be the most resilient postal operator, after recent self-help measures, such as parcel & stamp price increases, productivity improvements ands overhead savings, mitigating growing adverse Covid-19 effects..

Berenberg likes Deutsche Telekom:

•  Deutsche Telekom shares are nearly back to where they were before the COVID-19 sell-off. We think the next 20% up from here will be complicated, but possible, provided that optimism about the growth opportunity in the US is complemented by removal of the fibre-to-the-home (FTTH) risk in Germany. If that happens, the perception of the ex-US business (the stub) as a value trap trading at a discount to the sector should be transformed into that of a rare European telco offering growth and capex visibility, and deserving of a premium. We see potential for further re-rating of the stub, driven by material estimate upgrades for this segment, creating 20% upside in the share price. Hence, we upgrade to Buy with a DCF-based price target of EUR17.70.

•  Stub no longer a value trap: We had previously viewed the stub as a classic value trap - cheap on free cash flows pre-spectrum of cEUR3bn but set to decline from above-average COVID-19 risk exposure and an inevitable hike in German FTTH capex post-2021. However, a rethink of the near-term cost buffer and medium-term revenue potential of the stub, prompted by Deutsche Telekom's bullish guidance for stub free cash flows over 2020/21 (including COVID-19 effects), now leads us to believe that a progressive doubling of the pace of FTTH deployment in Germany can be achieved without sacrificing a free cash flow envelope of cEUR3bn. Our estimates for the stub even with the higher capex are now a material 20-40% above company-collected consensus.

•  US optimism likely to remain: T-Mobile US (TMUS) share price has been a stellar performer as optimism grows around the ability of the company to leapfrog the incumbents on network quality going into the 5G iPhone upgrade cycle this autumn. The next quarter will be a newsflow-heavy one, in which management will provide guidance on the Sprint merger, including an update on merger synergies while Dish (the remedy taker), and unveil its network buildout strategy. We think a reiteration by TMUS management of the medium-term target of USD10bn-11bn is highly likely. So long as this is the case, we would expect the shares to hold steady, given that the implied valuation post-synergies would be in line with peers'.

•  The path to EUR18, mind the dividend growth expectations: A re-rating of the stub to sector levels would mean upside to EUR17 (or 20% upside inclusive of shareholder returns) while a re-rating in line with safe-haven peers could yield EUR20 (or 40% upside). Investors might need to be more patient on dividend growth, as our upgraded free cash flows for the stub still do not cover the group dividend post spectrum costs and minority leakage. Hence, we do not forecast growth in the dividend until TMUS begins to pay a dividend to Deutsche Telekom, probably in 2024.

ISS, the Danish toilet cleaning people, is added to Goldman’s “buy” list.

We increase our estimates and upgrade ISS to Buy (from Neutral) as we see a double tailwind for the company: (1) higher demand for cleaning services as a result of the COVID-19 risk and general higher health/cleanliness awareness; and (2) a cost tailwind in the coming quarters from less tight labour markets, which should alleviate cost pressure. We increase our estimates and raise our 12m PT to Dkr180 (from Dkr125). Upgrade to Buy (from Neutral).

We increase our top line by c.4%/7% in 2020/21E as a result of the increased demand for cleaning services, and assume margins will be supported by this mix shift into a slightly higher-margin service, as well as weaker labour markets for several quarters to come. Our 2020-22 EBIT estimates increase by 17% on average.

Given the improved outlook, we increase our valuation multiple to 8.0x 2021E EV/EBITDA (from 7.0x). Our new Dkr180 PT implies over 50% upside. On our new estimates, the stock is trading on 8.7x and 8.1x 2021/22E P/E vs. a 5y median of 14.7x (and on 6.2x and 5.6x 2021/22E EV/EBITDA vs. a 5y median of 10.5x).

In addition, we see further potential upside should the new CEO (due to start in September) implement a successful restructuring of the company and bring margins back to the historical normalised level of 5-5.5%: In such a scenario, our bull case and blue sky scenarios imply per-share valuations of Dkr230 and Dkr250 by the end of 2022.

And Barclays really doesn’t like the look of French banks, having done some work on how much they’re lending to French people:

This note deep dives into the French banks’ consumer credit exposures. These are not often debated in the market due to light disclosure, but we believe they are the key driver of nearer-term impairments. Marking to market for consensus unemployment forecasts, we show how impairments from these books could cut consensus earnings estimates by 18%, 30%,and 34% next year for CASA [Credit Agricole], BNP and SocGen, respectively. That aside, we show how these businesses have contributed over 40% of group earnings growth in the last cycle as households re-levered, a performance that will be hard to replicate even if asset quality ends up benign. We downgrade BNP and SocGen to Underweight, with CASA at Equal Weight given its better outcome in this analysis. Valuations are a support and we do not see capital deficits, but we believe we are not yet close to the trough for earnings downgrades.

1. €300bn of higher-risk exposure that hasn’t been in focus: The more obvious challenges in the French banks’ corporate exposures have been well explored. However, the key risk relative to expectations is consumer credit, in our view, with only €250m of aggregate COVID-19 charges taken in 1Q20 on a broader book of €166bn, €80bn and €64bn at BNP, CASA and SocGen respectively. The early-cycle nature of the portfolio means we expect to see impairments rise quicker than other asset classes.

2. A key driver of earnings growth in the last cycle: Driven by both their successful standalone franchises as well as exposures through the retail networks, we estimate that consumer credit,as a whole,has driven almost half the earnings growth at BNP and CASA and more than 100% at SocGen since 2014.The driver has been close to double-digit volume growth, particularly in the car financing segment, as well as benign asset quality, neither of which looks likely to be replicated,no matter the shape of the recovery.

3.Losses will likely be high, even if buffered by more car finance: As unemployment forecasts stand and using disclosure from car finance specialist FCA Bank, we estimate peak loan losses to be 2-3x current consensus estimates for next year. State support and payment moratorium measures are less helpful than with other products, and ultimately unemployment forecasts into next year are the most important variable.

To be clear, we don’t think there is anything ‘wrong’ with these businesses but we see their loss content as underappreciated by the market. We cut our FY21 EPS estimates by 16%, 12% and 30% for BNP (PT€37.2 from €40), CASA (€9.9 from €10) and SocGen (€17.7from €23) to factor higher impairments at all three and CIB weakness at SocGen.The scope of earnings downgrades drives our UW ratings at BNP and SocGen. CASA is EW given the buffer from asset gathering earning

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