Markets Now - Tuesday 23rd June 2020

In a year so full of unpredictable headlines, the arrival of one in particular has brought with it a comforting sense of reassurance. Nature is healing:

Today’s recommended reading (supplementary to the FT’s award-eligible Wirecard coverage and a comprehensive FTAV archive of course) includes Bloomberg’s report on Project Panther, which apparently involved Wirecard pimping itself to Deutsche Bank last year. McKinsey & Company’s commissioned report is said to have viewed Wirecard as a “value proposition” that would boost profit and “fundamentally reshape the ecosystem”, just in case you had any remaining doubts about the value of management consultants. But what does it say about Deutsche’s understanding of its local market that it even asked for a McKinsey report in the first place?

Meanwhile, KBW’s Sanjay Sakhrani, the last sellside analyst to our knowledge to have a rating other than “Can’t Recommend a Purchase” on Wirecard, no longer has a rating:

We are moving to Covered-Not Rated for the second time given the uncertainty and lack of any concrete numbers to base any valuation on. The management board’s latest update calls into question the nature and contribution of the entire TPA business as well as the financial situation of the company. In an extreme scenario, if TPA business represents 30-50% of revenues with high margins, one can go down a path where a significant majority of profits could be wiped out with what’s come to light.

Wider market’s up, Wall Street having rallied into Monday’s close. The reason, in summary, seems to be “hooray, rising infections mean no end to the free money and Covid-19 is the market equivalent of perpetual motion”:

Hikma’s leading the FTSE 100 fallers after Boehringer Ingelheim sold its 16.4 per cent stake. Hikma will mop up 4.99 per cent for a maximum cost of £295m. Trade was all done at £23 a share, a 7.3 per cent discount.

BI took the Hikma stake as part of its sale of US generics business Roxane in 2015. This was all happening back when Teva had just bought Allergan’s generics business for $40.5bn, which marked peak drug insanity. Hikma had issued 40m new shares as part of the trade at £23.50 apiece which BI then bought on deal completion in early February at £18.81, having also renegotiated the cash portion lower. It’s therefore not a bad trade for BI.

Why now tho? Here’s Barclays:

[T]his could come down to a simple calculation that the investment is not a strategic one for BI and after long being in the red on its investment, today’s closing price will lock in a profit on this investment. We’d also note that the company’s US CEO (Dr. Wolfgang Baiker) will be retiring effective 1st August 2020 (announcement made on 15th June 2020). Hikma shares have clearly done well YTD, benefiting from both the March COVID-19 boost to the injectables business and also from the favorable ruling on Vascepa. Some investors we spoke to overnight have questioned whether BI’s decision could be tied to recent weakening trends amongst the IQVIA data though we would expect that some of the negative sentiment a share sale of this type would generally generate is at least partially offset by Hikma’s buyback.

Given that the company’s clean balance sheet is something that management has long spoken about with enthusiasm and M&A is certainly something investors have been looking forward to for Hikma, when asked why the company thought this was an appropriate use of the company’s balance sheet, management noted to us that it viewed this as a unique opportunity to purchase a significant proportion of its share capital, reflecting Hikma’s conviction in the business fundamentals whilst also being immediately earnings accretive. Hikma notes it has a strong balance sheet with comfortable capacity for this whilst maintaining financial flexibility when it comes to pursuing future strategic transactions. In terms of next events to watch for, we expect that the Vascepa legal process will likely be quiet for now as the appeal process begins, May IQVIA sales data will be released on 29th June and Hikma will report 1H20 earnings on 7th August.

Morgan Stanley just likes buybacks:

Based on our numbers, the share buyback would raise our expected 2020 Net Debt / EBITDA from 0.1x before SBB to 0.5x, still leaving Hikma with up to $1.6bn of firepower to do deals (in line with management’s strategy) assuming a maximum leverage of 3.0x ND/EBITDA end FY20. Assuming 12.2m shares bought (4.99% of total shares), the SBB would be accretive to EPS by 2.6% in FY20 and +5.3% in FY21 and beyond. The combination of the sale of the stake and the share buyback would raise free float (ex-Darhold and BI) from 59% to 74% of market cap.

We note the deal shares similarities with the Sanofi / Regeneron stake sale / share buyback that occurred earlier this year, with BI securing a profit on the sale of the stake (it entered the capital of Hikma in the context of the Roxane acquisition announced in 2015 when Hikma shares where valued at £23.5/share, although by the close of that deal in February 2016, the shares were trading at £18.8).

And Stifel just likes Hikma:

Hikma continues to drive good organic growth across its three divisions. Its injectables division appears to be benefitting from increased demand for hospital injectable products as a consequence of the COVID-19 pandemic, whilst its US generic business continues to recover from the severe pricing pressures seen in 2017 and its branded business benefits from strong demographics in the MENA region. Based on our revised forecasts, Hikma trades on a 2021E P/E of 16.6x, a 26% discount to its UK specialty peers. We see further potential upside to forecasts if Hikma’s gAdvair is approved by the FDA in September with the opportunity for Vascepa generics and nasal naloxone approval in 2021. Our revised target price of 2700p places the shares on a 2020E P/E of 20.2x, still a discount to its UK specialty peers.

Rightmove’s down after announcing more industry support and a warning. It’s giving giving a discount of 60 per cent on its membership packages for August and 40 per cent for September, while customers in Scotland and Wales will receive a 75 per cent discount in August and 60 per cent in September. This is expected by the company to hit 2020 revenues by £17m to £20m in addition to the £65-75m impact previously flagged, Rightmove having previously fumbled its 75 per cent discount for all agents between April and July.

The downgrade to ebitda from the new guidance is about 10 per cent, though that’s only half the problem. There are bigger questions with regards whether Rightmove’s pricing power is eroding, whether the lockdown has galvanised the forces of industry change, and whether 30 times 2021 is a fair price for a company that seems uniquely disliked by its customers. Here’s JP Morgan Cazenove with the summary:

Despite the positive consumer reaction to the reopening of the housing market, management highlighted that it takes three months on average for housing transactions to complete which impacts the cash flows of agents and hence triggered Rightmove to extend its support programme.

New property listings are returning to the market and in the last seven days the number of properties added to Rightmove in England is over 10% yoy. Usage of the market leading Surveyors Comparable Tool, which is used when valuing a property for a mortgage, is returning to normal with usage in England over the last week now only down 2% compared to a year ago.

The company further highlighted that overall membership at 31 May of 19,054 is down 3.8% since the end of 2019. This decline is made up of 620 fewer agency branches, together with a reduction of 135 New Homes developments. We would see this number as slightly disappointing giving the support measures implemented to support its customer base.

With regard to FY20 guidance, the company announced that “whilst the housing market re-opened on 13 May and early demand indicators have been strong, it is too early to assess whether this momentum will be sustained. We are therefore unable to provide guidance on future profitability.”

Some new numbers from Peel Hunt, which moves down to “hold” from “add” on valuation:

The company is not giving profitability guidance. However, with no indication of additional variations in costs, the impact of the further market support would fall mainly to the bottom line. This would suggest PBT of £120m and EPS of c11.1p. As a guide, every 100 agency members lost will cost £1.3m in a full year, so the additional 240 H1 agency reduction would equate to a £2-3m reduction in revenue and profit.

The shares have rallied well from the low of 420p and stand above our target price. We leave this unchanged as the longterm prospects are not affected by the near-term market support cost, and we have yet to see evidence of a wholesale reduction in agency membership numbers.

Morgan Stanley wasn’t too fussed about the conference call:

Overall, the tone from management was relatively positive – the company believes the recovery seen so far in the housing market is being driven by new interest as well as pent-up demand: new listings have been increasing and new buyer enquiries have also improved since mid-May. On the agent side, branch losses has slowed; more agents are adopting new technology and product take-up has been strong. Therefore, looking into 2021, the outlook for agents and for ARPA could be less bad than feared at this stage, in our view, although this is dependent on the shape of the macro recovery.

And Barclays sweats the structural stuff:

We view Rightmove’s announcement this morning as a modest negative, and also one that pushes some important questions around pricing power sideways rather than answering them definitely. As we see it, the likelihood of a price increase being possible for 2021E is getting smaller and smaller – it is hard to envisage getting successfully back to full rate card in October (itself a risk) and also negotiating an increase for 2021 (typically this would happen at the end of the year). These are exceptional times, but we have to question the structural pricing power here relative to classified peers: it looks as though it could take 3 years for Rightmove to rebound back to 2019 earnings. With the stock still on 30x our 2021E EPS (which doesn’t have a price rise but does have downside risk from lower customer numbers), we continue to see this as a source of funds and reiterate our Underweight rating.

The big thing in Europe is that Bayer might have reached a settlement for glyphosate/Roundup for a potential sum of $8-$10bn. The supervisory board is expected to approve in the coming week, Handelsblatt reports.

Here’s Goldman Sachs to say that certainty is better than uncertainty:

While we take no view on the likelihood/magnitude of the settlement, we note that the litigation has been a major overhang on the shares in the past year. We currently reflect this overhang in our SOTP with a 35% conglomerate discount, with Bayer having historically traded at a 15% discount (pre glyphosate litigation) to its SOTP. For context, every 5% reduction in the conglomerate discount translates into a c.€6 per share uplift to its equity value, all else equal. The $8-$10bn settlement range mentioned in the report appears in line with market expectations based on our discussions with investors, and would translate into c.€7-€9 per Bayer share.

While there remain several unanswered questions (e.g. future claims from other plaintiffs, the timing of the settlement), we would see any settlement (with clarity on limiting the risk of claims recurring) as removing a major overhang on the stock.

And Barclays:

From a financial and risk perspective this would clearly be a positive in our view and within the range of expectation (we have modelled a €7.5bn settlement since last Summer), though there is as yet no official statement from the company, details will be key (e.g. in terms of capping off future liability risk, how and when payments will be made, understanding how Bayer may continue to prosecute the legal process, etc) and whether it will have any bearing on EPA labelling and the future business (glyphosate-resistant traits etc). . . . 

We remind that with regards to the glyphosate settlement range, our base case estimate is €7.5bn with an upper bound of €12bn. With regards to the RoundUp ongoing cases, we note that the Johnson appellate case in the California State courts is the most advanced of the 3 appellate trials. Oral arguments were held on 2nd March and we await the initial verdict from the appellate panel that is expected within 90 days of oral arguments. Our Bayer estimates currently incorporate a €7.5bn glyphosate litigation payout, spread evenly across 3 years from 2020.

Over in sellside, Kepler Cheuvreux downgrades a load of banks as part of a big note on European bank stress testing. Credit Suisse, RBI and Deutsche all get downgrades:

While European banks can absorb our severe asset quality stress on capital (a -208bp overall impact on CET1 ratios), there are big variations between the banks under our coverage. The reduction in capital requirements (MDA) is particularly useful, with five banks ending up post stress scenario close to or below new/revised MDA levels versus eleven banks below the old MDA levels.

 We run a product/rating-based asset quality stress scenario based on pillar III disclosure. The severity of the asset quality deterioration is the main uncertainty plaguing the sector. We estimate the stressed expected credit loss at 1.67% of loans, well above our 0.62% COR expected for 2020E using a severe “point in time” deterioration of probability of default (PDs).

 We expect a -116bp negative impact on CET1 ratios from the negative RWA migration of the stressed PDs. This migration reflects rating downgrades as the likelihood of default increases. Banks using internal risk-based models (IRB approach) will be hit harder than banks using standardised approach.

 Few banks could get close to or below the new or revised MDA level (adjusted for lower countercyclical buffers, lower P2R, lower systemic risk buffers), which could trigger dividend cuts.

 Following the stress tests, the lowest MDA buffers are for: Deutsche Bank, SEB, Santander (not rated), RBI, CS, BBVA (not rated), Banco BPM, and Commerzbank.

 The highest MDA buffers are for: ABN Amro, Mediobanca, KBC, Nordea Bank, UBS, ING, and CASA.

 We remain UW on the European banking sector with a sector trading at 0.71x TBV for 6.7% RoTBV in 2021E and 7.8% in 2022E.

Our Most Preferred Stocks are UBS, ING, and Nordea, which screen particularly well in our asset quality stressed scenario, with a lower expected credit loss compared to peers and ending up with a strong MDA buffer post stressed scenario. These three banks are therefore well positioned to restore (or maintain) their dividend payments.

Our Least Preferred Stocks are Commerzbank, Banco BPM, and Natixis. Banco BPM and Commerzbank have been particularly badly hit in our asset quality stress scenarios, with a -352bps impact on the CET1 ratio for Banco BPM and -277bps for Commerzbank, putting both banks in the red zone on the post stress test MDA buffer. While Natixis proved quite resilient in our stressed scenarios, we decided to keep it in our Least Preferred Stocks due to: 1) company guidance is quite grim; 2) the bank remains exposed to “problematic” sectors - O&G, aeronautics, transport, real estate, infrastructure; and 3) developments at H2O in the course of this crisis have not been reassuring, and we believe that compliance harmonisation in the Asset Management division could prove costly for the group.

 We downgrade Credit Suisse from Buy to Hold: While Credit Suisse has one of the lowest impacts in our stress scenario (CET1 capital of 134bps versus the European average of 208bps), it still ends up with one of the lowest capital buffer versus its minimum regulatory CET1 capital ratio requirement of 10%. In our view, this demonstrates the bank’s thin capital buffer. Our asset quality review also shows a corporate portfolio (A-IRB) where high-risk exposures (single-B rating and below) represent 53% of the bank’s CET1 capital. This is one of the highest proportions in Europe.

 We downgrade RBI from Hold to Reduce: As RBI is among the weakest European banks in our coverage both in terms of digitisation standards and downside risk from COVID-19 on the credit book, we believe the current risk-reward profile is to the downside. As a result, we downgrade the stock from Hold to Reduce and confirm our TP of EUR14.5.

 We downgrade Deutsche Bank from Hold to Reduce: In our stress scenario, Deutsche Bank ends up with the largest CET1 ratio deficit versus its regulatory minimum requirement (54bp deficit). Our asset quality review also shows a corporate portfolio (A-IRB) where high-risk exposures (single-B rating and below) represent 90% of its CET1 capital. This is the highest proportion in Europe. DBK’s corporate portfolio also has one of the highest probabilities of default (PD) in Europe (5.5% vs. 4.3% for the European average).

Still on banks, SocGen’s sent around a slide deck that’s quite aggressively bearish on HSBC, BNP Paribas and BBVA. Sorry about all the tickers:

And Jefferies goes down to “hold” on Moncler, €36 target:

[W]e think valuation levels are too high: MONC remains one of the sector winners (not many will be left amongst the midsize players) and this should and will be reflected in multiples. That said, MONC is currently trading on 20x forward (2021) EV/EBIT, 16x EBITDA (pre-IFRS) and <3% FCF yield (34x PE if you look at that)...benchmarking vs last five years (when MONC delivered a 19% CAGR in EBIT) at an average fwd EBIT multiple of 15x. Unless recovery materialises much faster than we anticipate, it is not clear in our view where the upside is at this time. Downgrade to Hold.

2020 a Tale of Two Halves, but no miracles likely

H120 will be extremely challenging as for all peers: we est Revs -31% (all geographies negative) with EBIT swinging into a loss with important write-downs likely. H2 newsflow reversal is still the story and we look for Asia/RoW +28% YoY but other regions still negative...this implies -7% YoY. We expect F/W volume contraction as MONC focuses on profitability (possible Gross Mg mid-70s again, EBIT pre-IP at 29%) but still 24% below H219. COVID timing and MONC seasonality continue to help recovery but non-Asia performance under a lot of pressure. Upside here is if local Millennial spend ends up being far stronger than we think but lack of visibility makes us cautious.

We think there is a significant delta vs current consensus

MONC reports the latest consensus on their website with 20E Sales -10% at €1.47bn (JEFFe €1.38) and esp EBIT (rep) at €366mn (JEFFe €257mn) given our H1 est loss in excess 40mn. Implied mg is 17.5% vs 25%. Our net profit est at €157mn is -53% YoY and 1/3 lower than cons. too.

‘Brand First’ really is a thing here and IS important

Track record at MONC over the last decade is reassuring in terms of pricing, distribution and sell-out. We continue to think this will help it navigate the current crisis better than most premium apparel brands and help support a fast recovery: but we still think that means 2019 numbers beaten only in 2022 in spite of a likely healthy 2021 catch-up.

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