Markets Now - Tuesday 16th June 2020

Retail analysts, like war reporters, win no respect from their peers unless they get out into the action and come back showing some scars. For that reason we’re treated to a lot of sellside this morning about how long yesterday’s queues were outside Primark. It’s a pity that no investment bank analyst has thought to gauge the state of their own industry by checking the ratio of analysts looking at queues to people queueing, but perhaps that’s a datapoint for the next crisis.

Peel Hunt’s Jonathan Pritchard and John Stevenson have made a video observing how -- when it’s a gloriously sunny 23 degrees outside and also a pandemic -- shoppers seem to favour strolling their local high street to scuttling around a half-closed shopping centre. Bernstein’s Aneesha Sherman has also made a video, in which she senses that malls and retail parks will be best suited to cope with the New Normal. “We visited Crawley,” boasts Simon Irwin of Credit Suisse. Jefferies’ James Grzinic complains about finding “a very heterogeneous landscape” having taken some fascinating photos during a road trip between Kingston, Middlesbrough, Brent Cross and Westfield Stratford. Clive Black of Shore doesn’t say exactly where he went but does quote Aristotle.

You get the general idea. And just in case you don’t, here’s Jefferies’ dispatch from the front-of-store line:

Queue lengths made it rather obvious which retailers the English public had missed the most. There was a younger bias to shoppers on the first day of unlocking.

...with sporting goods and offline value for money key winners. Primark and TKMaxx attracted by far the most interest, despite no obvious changes to their commercial proposition. The queues here were longest, as pre-empted by accelerating social media engagement levels at Primark (see charts attached, also highlighting Primark's enduring value attractions despite competitors' markdowns, with Zara's basket price some 40% lower than when we last measured it in February). Both these formats seemed to be enjoying much larger than usual average transactions. Sporting brands were also in strong demand, with SportsDirect, JDSports and other sports footwear retailers proving popular destinations. Brand-wise the small size of the Adidas flagship in Westfield made it difficult to accommodate many shoppers at any one time.

M&S and (especially) Next looked quiet. In both instances there were no queues to enter stores. A number of rails of marked down fashion items were on display, with M&S also running some targeted initiatives (e.g. 20% off linen). No gross margin reinvestment was visible in commodities in either case. M&S' footfall benefitted from the attractions of the food offering (indeed in one instance M&S' food to go offering was fully shopped out by early afternoon). Engagement levels were even less encouraging in smaller chains.

H&M and Zara busy, but with very heavy markdowns. Both Zara and H&M proved very popular with the returning crowds. Queues persisted in front of both fascias for most of the day. The Spanish format typically displayed the longer lines, likely also reflecting broader levels of markdown activity (almost suggesting an earlier than usual shift to seasonal sales). A greater portion of the H&M floorplan was still trading at full price, but this was very much of a relative call. The greater bias to fashion offerings likely explained the significant amount of S/S merchandise on sale.

None of this stuff is doing anything to share prices today, which are up after Wall Street rallied from an early loss of more than 2 per cent to end up nearly 1 per cent. The trigger was probably the Fed saying that from today it’ll make direct purchases of individual corporate bonds via the emergency lending programme. (The Secondary Market Corporate Credit Facility has been buying ETFs since May 12.) If there was any doubt left that the Fed is the market it’s now been erased, and questions are why we’re throwing absolutely everything at tightening credit spreads when there’s seemingly no financial sector crisis can wait for another day. Here’s BoA to say, “Lord, reattach us to fundamentals, but not yet”:

By delivering on the SMCCF in the way investors expected following the announcement, the Fed preserves 100% credibility. We think eligible bonds could outperform for another two weeks and then investors are pushed into non-eligible.

And Canaccord to develop on the point:

One reason the market moves lower in a bear market is investors typically have to wait for the Fed to figure out how serious the problem is, but this Fed has been way ahead of the curve since late March with very clear language that has been backed up with action as evidenced by yesterday’s SMCCF expansion. This monetary support has led to a historic rise in Money Supply (M2) and a Personal Savings Rate of 33% suggesting there is ample liquidity to spend once we fully reopen economic activity. . . . 

Financial Conditions are easing. How do we know the Fed has been ahead of the curve? Typically, there is significantly more tightness in Financial Conditions in a recession. Most economic data series have seen the worst readings since the Great Financial Crisis (GFC) or Great Depression, yet the Chicago Fed National Financial Conditions Subindices are showing continued improvement and never reached a level of stress that is associated with a recession (Figure 3)

The economy is moving off worst levels. One reason the market typically accelerates to the downside in a recessionary environment is a fear the economy can keep getting worse. When the government forced a shutdown to contain the risk to the healthcare system, we saw a historic rise in the U.S. Unemployment Rate (Figure 4) and a collapse in nearly every economic data series. As a result, the Citigroup Economic Surprise Index dropped to the lowest level since the GFC and within just two months has seen a record rise (Figure 5). Clearly, expectations became overly pessimistic.

Covid-19 vaccine appears closer. On top of Moderna’s (MDNA) announcement in May that it was seeing success in developing a vaccine, Johnson & Johnson (JNJ) stated last week it was accelerating its human clinical trials from September to July, and Regeneron (RGEN) announced it is also beginning first clinical trials of a COVID-19 antibody drug. These suggest a higher probability of a more aggressive economic reopening in 2021.

Summary – We want to add risk as the consolidation plays out. At yesterday’s low, the SPX was down 8% from the recent peak on fear of another wave of Covid-19 spread and the potential for a second economic shutdown. As stated above, the market swings have been at lightning speed and we believe many of the uncertainties that typically surround a crisis are on the path to recovery, albeit a choppy one pending broad distribution of a vaccine once approved. Our view since the April FOMC meeting has been to follow the Fed because they print the money and are actually putting it to work. After the recent ramp to SPX 3200, we continue to expect the market to spend the next few weeks in consolidation mode and would add to the economic reopening sectors on weakness. Despite the recent market consolidation, the leading areas since the trading range breakout on 05/26 have been the Banks, Industrials, Materials and Consumer Discretionary sectors and we see no reason for that to change once we have a clearer path to reopening with such historic monetary and fiscal stimulus.

One important detail here is that the bond issuers “do not need to provide certifications”, meaning everyone gets a car. Here’s Goldman Sachs:

The removal of the requirement for issuers to “opt-in” to the SMCCF is unquestionably positive for corporate credit spreads, in our view. While the Fed did not commit to deploying the entirety of the SMCCF’s capacity ($25 billion, leveraged 10x for IG-rated bonds, 7x for the post-March 22 fallen angels, and 3 to 7x for “any other type of eligible asset”), today’s announcement provides much more flexibility to validate the strong announcement effects that were delivered on March 23 and April 9. In addition to further supporting risk appetite, today’s announcement will likely fuel more portfolio rebalancing across the quality and maturity spectrums, given more compressed risk premia for the high-quality segments of the market (Exhibit 2) and a backdrop of accelerating sequential growth.

To be more specific, we highlight three primary implications.

First and foremost, today’s news increases upside risk (i.e., tighter spreads) relative to our forecasts. The Fed’s posture has shifted from a “lender of last resort” towards more of a regular market participant – similar to that of the ECB and the BoE. This was not reflected in valuations, in our view, suggesting spreads should move tighter from current levels.

Second, this shift supports the case for compression across the quality spectrum, between IG and HY, as well as within IG. The positive interaction between the flow of purchases and reaccelerating growth will incentivize investors to rebalance their portfolios down in the quality spectrum – especially now that IG and HY spreads are comfortably out of recession territory. This leaves us comfortable with two key relative value views: (1) our preference for HY over IG in the USD market, and (2) our preference for BBB-rated bonds over their single-A peers.

Third, while the SMCCF remains focused on five-year and shorter maturities, we still have a preference for intermediate maturities within IG. Now that front-end IG spreads have retraced the majority of their March 2020 underperformance, we recommend investors move further out the curve to pick up yield.

In response we’re having another one of those melt-ups where the rising tide of liquidity lifts all boats, which means it’s going to be a challenge to piece together any market report this evening that’s longer than one sentence. Here’s the mid-session scoreboard, which is also being juiced by talk of yet another $1tn US infrastructure proposal:

This latest $1 trillion infrastructure proposal is completely different from Trump’s other infrastructure proposals, to be clear, such as his $2 trillion infrastructure proposal in March and his $1.5 trillion infrastructure proposal in 2018. Perhaps when all this money arrives the United States can be paved from coast to coast, as Joni Mitchell foretold.

UK corporate wise, there’s not much. Daniel Kretinsky and Patrik Tkac are up to 8.2 per cent of Royal Mail, from 7.13 per cent previously, via their Vesa Equity Investment vehicle. That’s about it really.

Among the sellside, UBS is pushing British Land and Land Securities. Discounts of 47 per cent to March 2020 NAV don’t look right, it says:

Landsec and British Land are trading at steep discounts to heavily written down asset values. We are cautious elsewhere in the sector on retail exposure, as our thesis there is that recapitalisations may be required. In the case of Landsec and British Land, the London office side (53%, 61% respectively) and the manageable leverage (31%, 34%)mean we have little concern either are heading down that path. Both have suspended dividends, and the outlook over retail rents is highly uncertain. We take a detailed look at where the dividends could resume at a realistically rebased level. With bearish assumptions, resumed dividend yields could be ~5.5-6% and sustainably grow. In the case of Landsec, new management and the strategic review present potential catalysts over the coming months, although Brexit remains a lingering risk. We are Buyers as we see risk/reward skewed up, given valuation is as cheap as it has ever been.

Why the discount?

We highlight five reasons, with retail exposure being the main one. Although there is likely more pain to come in retail, we believe the 33% discount to GAV and a c.7.3% implied yield provides a generous buffer. Retail values have already been written down 35% and our estimates show peak-trough of -55%, while our PTs equate to 28% discounts to trough NAV. In our price per square foot analysis, British Land's portfolio is back at 2012 levels, while Landsec is trading back at 2014.

We have updated our estimates and valuation post FY results. We cut our Landsec PT by 27% to 800p which represents a 32% discount to Mar-20A NAV and an implied yield of 6.7% at our PT. The FY22 dividend yield on our newly rebased estimates stands at 5.7%. We cut our British Land PT by 30% to 520p which represents a 34% discount to March actual NAV and an implied yield of 6.6% at our PT. The FY22 dividend yield on our newly rebased estimates stands at 5.5%. This is driven by a 23% decrease in retail rents, as well as lower portfolio valuations going forward.

Premier Oil goes up to “buy” at Investec:

Premier Oil is our preferred leveraged play in the sector and we upgrade to Buy with a 55p/sh target price. We upgrade following the renegotiated BP acquisition and the ARCM settlement agreement that aligns it with the upcoming refinancing, expected to conclude Q3/20, before raising equity to fund the $210m BP deal. We expect incremental progress by month-end, as creditors give the BP deal consent and covenant waivers. Despite recent strong performance, Premier lags the oil price recovery (20% behind oil price/peers) and on higher oil prices offers significant upside potential (130% to RENAV at $60/bbl) flat).

End of ARCM saga: Premier recently secured a way forward with ARCM, its largest creditor (over 15% overall), that had previously blocked the BP acquisition. Following a $27.5m equity issuance to ARCM (at 27p/share), the hedge fund reduced its short position to c.7% (previously c.17%). ARCM’s exposure is now debt weighted and they have undertaken to support the BP acquisition and covenant waivers.

Accretive BP deal renegotiated: The re-cut BP deal (Andrew Area and Shearwater fields in the UK North Sea, c.23kboe/d net) brings down the consideration payable significantly, to $210m upfront (previously $625m) and c.$240m of pre-tax decommissioning obligations (previously c.$600m). The company expects to fund the acquisition with equity and we assume $190m raise at 35p/share (c.15% discount to the current share price). The deal is cash flow accretive and brings forward utilisation of $4.1bn UK tax losses.  Refinancing, extend maturity: Premier should secure covenant relief later this month ahead of a comprehensive refinancing. The existing credit facilities mature in May 2021 and we anticipate that through negotiation in Q3/20 the maturity will be extended to Nov 2023 (in-line with the announcement in January).

Better placed this time around: As we detail in this note, the share price performance remains linked to an improving oil price environment (and increasingly, the UK gas price). However, in contrast to previous years, the company has adequate liquidity ($490m cash and undrawn facilities) with no major capex demands and the potential to reduce FY21 capex to $150m (from $320m in FY20E). This is underpinned by a strong underlying asset base with progress on the Tolmount development expected later this year (topside sail away in August, ahead of first gas Q2/21)

Admiral’s down at Peel Hunt:

Admiral has shown a steady share price performance over the past few years and its motor book has proved to be defensive amidst the Covid-19 fallout. However, it will not be immune to the recessionary impact of Covid-19. The underlying benefit of positive motor claim trends will be offset by customer relief measures and impairments to both non-performing premiums and loans. As such, we have lowered our adjusted EPS by -14%/-17% in 2020E/21E to 117p/108p and a similar reduction in DPS. We lower our TP to 2,120p (from 2,230p), and despite ADM’s quality, with 6% downside we downgrade it to Reduce (from Hold) on valuation grounds.

And Sodexo goes down to “neutral” at Citigroup as part of a contract caterer review:

Social distancing data points to a progressive return to work in many countries. These, and broader signs of optimism have helped the caterers to rally off lows but it is clear that ongoing social distancing requirements will mean that FY21 will also be challenging, second wave risks are also appearing. We assume that earnings largely recover in FY22E and this creates the basis of our ongoing positive investment view. All four companies are trading close to 5-year EV/EBITDA troughs with the exception of Elior which trades at a substantial discount.

We expect operational disruption will continue through FY21 and following our recent cuts to Compass FY21E forecasts we make similar changes for the other companies. We expect revenues and margins to only partially recover through FY21 as operators grapple with low attendance and higher operating costs, as well as possible second wave risks. We think that investors should therefore focus on FY22 for more fully recovered earnings, although this ultimately depends on a successful vaccine being rolled out.

CPG’s equity raise surprised the market and its position arguably looks too comfortable with some questioning the issuance of equity at such a low share price. We detect little desire for other companies to follow suit for the same reason, especially as covenants/liquidity for peers continues to look robust barring a materially worse than expected trading outcome. Under our bear case scenario ARMK and CPG balance sheets look solid, Elior could remain challenged for over a year after current waivers expire. Sodexo has yet to secure covenant waivers.

Although the shares have rallied off lows they are still trading close to five-year trough EV/EBITDA multiples which seems a fair basis given risks to the earnings recovery. We remain Buy rated on ARMK and CPG but downgrade EXHO to Neutral on risks to management guidance and covenant concerns. We upgrade ELIOR to Buy given its deeply discounted valuation, although acknowledge that risks remain on its balance sheet.

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