Broker tips: Chemring, Rio Tinto, Paddy Power Betfair
Chemring tumbled on Friday as Barclays cut its stance on the stock to 'underweight' from 'equalweight' and chopped the target price to 185p from 258p as it said company-gathered consensus is "materially" outdated after the Salisbury fatality in August and the premium valuation is unjustified.
Barclays said it sees "strong" de-rating potential around the pre-close trading update, due on 15 November, as the full financial impact on earnings and cash from the Salisbury incident is recognised on a multi-year basis.
Chemring said last month that a blast at its Countermeasures facility near Salisbury that resulted in one fatality and one critically injured employee would dent full-year underlying operating profit by £15m. This was in the middle of the range it had given in August.
Barclays also pointed to a material revenue deceleration relative to UK defence peers.
"Even factoring in the partial offset generated by the H118 uptick in order intake for Countermeasures USA, we now forecast organic revenue decline of 11%/4% in FY18/19, versus the broadly flat UK defence average of circa 1%," it said.
The bank also noted that Chemring's share price has risen 16% year-to-date, having largely recovered from the Salisbury announcement in August.
"In our view, the market appears to be treating the event as one-off in nature and ‘in year’. This is despite consensus FY18E/19E earnings per share having fallen 26%/10% in the past three months. We think the stock looks overbought on both a relative and an absolute basis."
RBC Capital Markets adjusted its estimates on Rio Tinto on Friday, noting that challenges posed by elevated input costs had continued to erode EBITDA margins in the mining giant's aluminium unit.
RBC said that as input costs remained elevated, with some smelters being affected more than others, the cost of raw materials in Rio's aluminium division had continued to erode EBITDA margins across the group, with the total incremental bill for the year estimated to be roughly $500m.
The Canadian broker stated that once the sale of Rio's Dunkerque smelter is completed and, assuming the re-initiated sale of its Icelandic smelter is successful, close to 960 kilotons of alumina will be released. RBC expects the excess alumina will be sold to the market when the volatile alumina/aluminium market has consolidated, helping offset some of the costs associated with its legacy contracts in the Pacific.
However, with access to cheap power becoming a key competitive advantage in the smelting business, RBC said it still saw Rio Tinto as being "well positioned to benefit in the medium term", highlighting the miner's Canadian operations as a "sustainable competitive advantage" due to their hydropower capacity and Elysis JV technology.
RBC marked-to-market for the third quarter, increasing the cost of the legacy alumina contracts for the second half of the year by $100m, and incorporate the $3.2bn buyback announced.
"We maintain our 'underperform' rating as Rio Tinto trades at 7.8x 2019E EV/EBITDA, a premium to peers at 5.3x."
The broker also reiterated its 3,200p price target on Rio Tinto.
Elsewhere, analysts at Berenberg upgraded bookmaker Paddy Power to 'hold' on Friday, noting that it believes recent scepticism surrounding the newly opened-up US sports betting market had been "premature".
Berenberg's current analysis valued the market opportunity at as much as $25bn per year, of which it believes Paddy Power could take 15% "over the long-term". The broker also praised Paddy Power Betfair's joint-venture with FanDuel for affording the group an attractive opportunity to align itself with an established brand and also highlighted further benefits provided to it via land-based partner Boyd Gaming's distribution capabilities.
While the German broker did cut its price target on Paddy Power Betfair from 7,000p to 6,500p, its analysts said the recent slump in share price meant they now actually saw some upside, prompting them to revise their rating from 'sell' to 'hold'.
"Despite the few challenges still remaining, we think most of the negatives are priced in," they said.
Berenberg now thinks that the US opportunity is "more interesting" than it had initially thought. However, the broker still highlighted risks as Paddy Power's underlying established business had "only just started improving".
Indeed, stripping out the US sports betting opportunity, the broker noted that it still saw "significant downside potential", suggesting that taking a cautious approach may be the best.
However, on the upside, Berenberg acknowledged that the group's digital gaming business, as well as the Paddy Power brand itself, had "shown signs of improvement" – if the outfit was capable of maintaining this improved performance, the broker said a "more positive stance on the shares would be justified".