Broker tips: Glencore, AB Foods, Enquest
Glencore got a lift on Monday as Morgan Stanley upped its stance on the stock to ‘equalweight’ from ‘underweight’ and bumped the price target up to 280p from 230p, saying financial risk has mitigated and it is now on par with peers.
“Reinvestment or return of excess cash is the key value driver ahead. Here, the group's options and track record are comparable to peers.”
The bank said that the downside to its new price target and the risk reward skew is comparable also. It pointed out that Glencore's estimated 2017 free cash flow yield of 2.5% is similar to its diversified peers at 11.9% on spot.
“A payout ratio based dividend policy ensures the bulk of free cash flow will flow back to shareholders. It also has reinvestment opportunities to generate some growth. Finally, in 2015/16 the marketing division has demonstrated its countercyclical cash flows in a weak commodity price environment.”
MS said it expects near-term earnings growth to be driven by extra volumes in African copper and global zinc.
It reckons that on spot prices, higher production from these assets will add $3bn and $0.75bn to earnings before interest, taxes, depreciation and amortisation, respectively, versus group EBITDA of $10bn in 2016.
Morgan Stanley also upgraded Associated British Foods to ‘overweight’ from ‘equalweight’ and lifted the price target to 2,800p from 2,650p.
Although the bank has not materially changed its valuation for Primark, of about £15bn, it has increased its valuation for the sugar business to reflect improving prospects. This leads to the target price increase and with 12% implied upside potential, the bank has upped its rating on the stock.
MS said the share price drop of around 30% in the last 10 months was overdone. It noted the shares have fallen despite consensus earnings forecasts marginally increasing.
“Primark remains an excellent long-term international growth story and its margin problems are temporary, in our view. We think it very plausible that its profits could grow by more than 40% next year.”
MS said investors have become too focused on Primark’s like-for-like sales. It said although sales have slowed, it remains a very healthy business.
“Even without any online sales, its sales densities are 25% higher than those of Inditex and double those of H&M. And, unlike H&M, its densities aren't declining over time, so we don’t see it at risk of operating deleverage.”
MS said that if Primark continues to grow sales by 10% a year and its margins in FY 2017/18 recover to the same level as FY 2015/16, “it is a matter of simple mathematics” that its profits will grow more than 40% next year.
“We don’t factor this degree of margin recovery into our base case forecasts yet, but we think it a plausible scenario (something very similar happened in FY 2012/13). And if it does happen, Primark's implied valuation multiples would suddenly look very low indeed.”
Exploration and production group EnQuest got a boost as UBS upgraded the stock to ‘buy’ from ‘neutral’ and upped the price target to 65p from 60p.
The bank had downgraded its stance to ‘neutral’ in January, saying that although the company’s cash flow was impressive, a 113% jump in the share price since the placing had left the Kraken start-up risk fairly price.
Since then, UBS noted that three things have happened: January's trading statement saw near-term production guidance disappoint; the shares are down more than 20%; and EnQuest has announced a highly accretive deal with oil giant BP.
“We think the shares overreacted to the trading statement and don't yet reflect the deal value potential” it said.
On 24 January, EnQuest announced an agreement to buy a 25% operated stake in BP's Magnus field, with options to acquire the remaining 75% and/or manage some of BP's decommissioning liabilities.
UBS said the deal makes clear financial and strategic sense.
“The innovative 'cashless' structure makes it accretive to EnQuest at almost all oil prices; it plays to EnQuest's strengths as an operator of late-life assets; and it accelerates recovery of $2.5bn in UK tax losses.”