Catching up with bottom up developments

Wednesday, 2nd March 2016 09:49 - by David Harbage

As promised in the last blog, which highlighted our selected leaders’ performance last month and the investment community’s view of their prospects, we will now take a look at the company specific (the ‘bottom up’, as opposed to the ‘top down’ macro-economic) news flow that has driven such returns.

Aviva acquired the motor and home insurance divisions of RBC Insurance (part of Royal Bank of Canada) for £281m on 21 January. This operationally accretive purchase bolsters Aviva’s leading general insurance business in Canada by 20%. Under CEO Mark Wilson, Aviva has been re-arranging its portfolio of assets – both by business activity and geography – and this ‘bolt-on’ appears very sensible as its Canadian general business is enjoying healthy profit growth (up 59% to £132m at the 2015 halfway stage) and a declining combined operating ratio (compares premiums received to claims paid out) from 96.8% to 91.9%, which is better than its domestic performance.

BT Group pleased the market with better than expected quarterly results on 1 February. Underlying revenue growth of 4.7% represented the telecommunication firm’s best top line result since 2008, and reported earnings per share for the last three months of 2015 rose 38% to 9.5p. These numbers followed advice that the acquisition of mobile telephone operator EE had completed, and were accompanied by news of a divisional re-structure featuring Consumer, EE, UK business, Global services, Wholesale services and Openreach. Notwithstanding an expensive entry into Champions League football and move back into mobile telephony via EE, the group appear to be winning its high risk-reward strategy to maintain and grow its customer base – taking 71% of new broadband customers in the quarter.   

Capita has been highly successful in winning contracts to carry out a wide range of support services for businesses and in the public sector. However, results announced on Feb 25 showed a slower pipeline of new business than expected, which prompted the shares to slide 6% on the day of the announcement. The full year results in themselves made for good reading: profit before tax up 9%, as were earnings and the dividend pay-out, on a 7% increase in turnover. Capita’s focus on higher margin business (seeking 13%-14%) – evident in exiting some smaller, less profitable business and making £400m+ of acquisitions – has clearly worried some, but winning 2 out of 3 contracts (by value) applied for, totalling £1.8bn represented progress on the previous year. Last year’s purchase of Avocis promises geographic diversification into Europe. Mixed opinions remain amongst the Sell side, post the results: Goldman Sachs (price target 980p) and Panmure Gordon (£10) are negative, while Jeffries (fair value 1370p) and Nomura (1303p) remain positive. Taking cost of the balance sheet via outsourcing is a trend that looks set to continue – especially if government finances remain under pressure – and Capita, which has avoided the scandals that have impacted peers (like G4S) over public contracts, represents the most obvious beneficiary.

easyJet suffered setbacks in the final quarter of 2015, it emerged when the budget airline provided the market with a trading update for the final quarter of 2015. The tragic events in Sharm El Sheikh and Paris led to cancellations at the Egyptian holiday centre and affected demand to travel to the French capital. Despite those temporal factors, the period witnessed an 8.1% rise in passenger numbers to 16.1m, while capacity grew 7.3% to 17.8m seats, boosting the load factor 0.6% to 90.3%. While revenue per seat fell 3.7%, the airline reduced costs by an impressive 6.2%; adverse foreign exchange movements cost the group £32m. Cost reduction is driven by lower fuel (worth £2 per seat), the increasing use of the more efficient A320 aircraft (saving 10% compared to the A319) and higher traffic means lower airport costs. Beyond operations, strong cash generation and a healthy balance sheet suggests the company is well positioned for medium term growth; investors are getting a 21% hike in dividend and net cash of £266m is allied to a Euro 3bn MTN (medium term note) programme.

Greene King’s trading statement on 10 February pleased its shareholders and confirmed that the consumer is continuing to spend in its enlarged (post the acquisition of Spirit, which includes the likes of Chef & Brewer) pub estate. Like for like sales were 2.2% higher in the 40 weeks to Feb 7th, with the two weeks of Christmas seeing 5% L-f-L revenue growth. Official beer of England cricket Greene King IPA is proving popular in China and own-brewed volumes rose 3.9% with Old Speckled Hen a major driver. The integration of the Spirit business, featuring rebranding in places, is proceeding to plan and management expressed confidence in the immediate outlook. A £0.25m share purchase by a director on 11 February encouraged investors, who favour domestic growth opportunities. Retracing towards their 977p all-time high, reached on 4 December, would have the stock knocking on FTSE100’s door.

HSBC disappointed the market when announcing flat final results for 2015 on 22 February, as profits fell short of best expectations. Sentiment towards big banks is unlikely to change in the short term – driven by the threat of further financial penalties from regulators, as much as by slowing economic activity and ever lower interest rates (and accompanying margins). However, the dividend does not appear at immediate risk (36p and 37p forecast for 2016 and 2017 respectively), with earnings per share of 48.5p and 53p anticipated. An income yield of 7.7% should provide support at these levels, but investors seeking growth will have to be patient; there appears little reason to rush out and buy the stock.

By contrast, the recently renamed Imperial Brands (from Imperial Tobacco) pleased the market on 11 February when reporting a trading update covering the final quarter of 2015. Against a backdrop of a 3% drop in tobacco volume, the company’s focus on growth & specialist brands (equates to 57% of group revenue) and cost containment (£55m savings expected in the current year) has merit. A first full year’s contribution from the American ITG Brands business is expected to exceed expectations and, alongside the promise of dividend growth of at least 10% this year and next, has seen the shares maintain their positive momentum.

Elsewhere, amongst our selections, consumer leisure stock Sky revealed that it had grown revenue by 5% and seen costs almost match that, at 4%, in the second half of 2015. Continued high investment in technology, sports rights and programming is required to maintain its compelling proposition. Against a backdrop of net debt of £5.7bn, the interim dividend was increased by just 2%. In April James Murdoch will succeed Nicholas Ferguson as chairman of Sky and in the same month Dr Marjn Dekkers (currently the CEO at Bayer) succeeds Michael Treschow as chairman of Unilever.

A pickup in revenue growth and in the trading profit margin (to 4% and 23.7% respectively) within the 2015 results at healthcare group Smith & Nephew encouraged investors to push the stock towards its all-time high, reached on the last working day of 2015. The full year results from Unite Group, the property company which provides accommodation to university students, appeared particularly impressive – featuring 33% growth in EPRA (fair value adjusted) net asset value to 579p, a 66% jump in EPRA earnings per share and a 34% hike in the dividend – but this pace of progress had largely been anticipated by investors. Management’s intimation of increasing competition from other accommodation providers, itself encouraged by the high levels of investor interest in the sector, provided something of a dampener on sentiment.

The prospect of rental growth accelerating (from 2015’s 3.8% pace), student numbers increasing (intake for 2015/16 was 3.9%) and the intention of converting to a REIT (which would provide a 10% fillip to the dividend distribution) suggests the growth story has further to run.      That the shares of real estate group Workspace should go from an all-time high of 987p on 5 January to a 52 week low of 713p five weeks later – without any apparent reason – is something of a mystery. Directors have not sold and the stock is tightly held by ten, mainly institutional, investors.

Eight brokers have issued research notes since the 11th November, when the half year results were announced, and each placed a Buy recommendation on the stock and a fair value or price target of at least £10. The interim management statement, released on 22 January and covering the period from 1 October 2015, provided reassurance on rental growth (like-for-like up 2.3% in the final quarter of 2015 and +11% since 1 April 2015), a high level of occupancy (91.2%, like-for-like) and on the immediate future, based on a pick-up in 2016 in enquiries for its units (Workspace has 4,725 lettable units on 77 estates in the London area).