To quote Vladimir Lenin, “There are decades where nothing happens; and there are weeks where decades happen.” And to quote him again: “A newspaper is not only a collective propagandist and a collective agitator, it is also a collective organiser.”
The author having already lived through several decades since Monday is choosing to skip today’s markets propaganda and agitation and act only as a collective organiser. The collection that follows is knife-catching sellside. Normal service resumes on Monday.
Here’s BHP etc being upgraded in a sector note from JP Morgan Cazenove.
European Miners are -40% since mid-Jan vs Chems -20%, Oil & Airlines -48%. In the aftermath of 2008/16 Miners gave strong outperformance, driven by China policy support & its quicker economic momentum. We see parallels today as JPM forecast China Q2 GDP at +57% QoQ. Unlike previous crises, BHP, RIO & Anglo have low balance sheet risks; ~0.5x ND/EBITDA at spot commodities, or ~1.0x or below if prices fall -20%. Dividends are attractive (7-10% yields) & resilient vs Euro cyclicals, which may entice rotation for income. Despite COVID-19 risk we see rare buying opportunities in Anglo & BHP -50%/-40%. We upgrade BHP to OW with ~70% upside to our £18.40/sh Dec-20 PT. The outsider is Glencore (UW), where credit metrics are likely to miss those required for its BBB+/Baa1 rating at spot prices. An investment-grade credit rating is the lifeblood to Marketing and key to GLEN’s business model in our view.
Third wave of Miners’ outperformance post GCC? From 2009 Euro Basic Materials rallied +170% and +150% from 2016. We don’t expect such extreme upside post Q1’20 as balance sheets risks are low, but this also means risk-adjusted returns are superior & are lower vs other cyclicals. Our constructive view does not demand higher commodity prices – we calculate BHP’s shares already imply $45/t iron ore (~50% below spot) and RIO’s shares imply $60/t.
Upgrade BHP to OW: We see a rare multi-year, entry point in BHP. Its share ratio vs RIO is at its weakest in 15 years & is trading on 1.3x P/Book vs its 2.6x 22-year average and RIO currently on 1.5x. BHP has a strong balance sheet (0.5x ND/EBITDA) & ~8% dividend yield.
Anglo falls to “close your eyes & buy” levels: Anglo has fallen ~50% since mid-Jan to a market cap of just ~$16bn. Yet, it has low debt (0.7x ND/EBITDA) & the highest quality & highest growth project pipeline of the majors in our view, in copper, palladium and diamonds.
Our Glencore UW thesis is playing out: Higher debt, inferior asset quality vs peers & greater strategic urgency to reinforce its investment grade credit rating, mean higher risk to dividend sustainability, mine viability and Industrial cash flows in 2020/21. We do not expect a near term credit rating downgrade but estimate metrics are unlikely to sustain a BBB+/Baa1 if spot (or lower) prices are prolonged.
Aggreko etc, upgraded in a sector note from Jefferies.
We favour stocks where a recession is almost priced in and are wary of over-leverage. The market is preoccupied with short-term headwinds, but some business models have proven resilience, so we upgrade Compass, Sodexo and Bunzl to Buy. We are concerned about SGS’s dividend sustainability so downgrade to Underperform. Recruiter shares have been savaged, but balance sheets look safe, so we raise Hays/Page to Buy and close out our Underperforms on Adecco/Randstad.
We favour stocks where recession is almost priced in and ND/EBITDA is <2x. We update ratings after a period of elevated share price volatility and apply the following framework: 1) We favour stocks in the bottom quartile of our “percentile ranking” screen as they have almost priced in a recession. We have used this framework in the recruitment sector for a decade to provide a useful assessment of risk/reward; 2) We remain wary of over-leveraged balance sheets and our newly upgraded Buy stocks have <2x ND/EBITDA. Our Underperforms often exceed 2.5x; 3) We favour high FCF conversion and earnings quality.
Upgrading Compass/Sodexo to Buy. In our view, the market is preoccupied with short-term headwinds. Trading will be negatively affected by school closures, cancelled Sports & Leisure events, and more working from home by employees of Business clients. However, these are transitory events, caterer business models have proven resilience during previous downturns, valuations have pulled back, balance sheets are safe, and inflation headwinds should ease.
Upgrading Adecco/Randstad to Hold and Hays/Page to Buy. We have often highlighted late-cycle characteristics in the US labour market over the past year, but recruiter share prices have been savaged, are now pricing in a high probability of recession, and balance sheets are safe.
Downgrading SGS from Hold to Underperform. Although the balance sheet is comfortable, SGS distributes 90% of FCF and EPS as a dividend and cover falls to a mere 0.7x in a recession scenario. We downgrade EPS by 15-25% and expect a dividend cut from CHF80 to CHF65.
Upgrading Bunzl from Underperform to Buy. Even in a recessionary scenario, Bunzl has comfortable leverage and dividend cover. We remain concerned about margins and competition, but the business model has proven resilience during previous downturns and the balance sheet provides optionality.
We downgrade EPS to accommodate COVID-19 disruption and our economists’ view that Europe will dip into recession but the US will be more resilient. There is a common theme from our recent dialogue with management – most anticipate headwinds but few can predict the precise impact. We assume the modest European downturn in H120F is similar in magnitude to 2012 and 2003/2004, with Q2 particularly bad, and drop-through amplified when variable costs can’t be flexed rapidly.
EPS revisions are typically 10-20%. Our current year EPS downgrades are typically 10-20%, taking us below consensus by a similar magnitude. Year two is less material as we are mindful to model a rebound in activity after the H1 “air pocket”. Revisions are a more modest 0-10% for resilient business models.
And again BHP etc, upgraded in a sector note from Liberum.
We had been bearish on BHP, Rio Tinto, Anglo American and Ferrexpo, because we expected the iron ore and coking coal price to collapse. They have not, but the share prices have plummeted anyway. The de-rating in the equities versus the underlying commodities and FX has been extra-ordinary and effectively prices in the collapse of bulk commodities. For instance, if Rio Tinto were to trade at a mid-cycle spot multiple of 5.0x EV/EBITDA, it is currently implying an iron ore price of $53/t versus spot of $88/t. Iron ore can indeed go lower and probably will eventually, but we would also expect the shares to re-rate to bottom of the cycle multiples. As such we are upgrading the iron ore names BHP, Rio Tinto, Anglo American and Ferrexpo to HOLD from Sell. Across the rest of the commodity spectrum we are largely in the cost structure and expect increasing rationalisation of mine supply and growth projects. Hence, whilst we struggle to be outright bullish in this environment, we believe the remaining downside for the companies that are not facing liquidity concerns or marginal producers is limited.
Pets at Home, upgraded at Berenberg.
[W]e were becoming increasingly confident in the underlying momentum in the Pets at Home business. It has fallen by c35% in the past month, but we believe it shares some (albeit not all) of the characteristics of the UK grocers, which have been rewarded with broadly flat performance in the current market turmoil. As a result, we upgrade our rating to Buy.
Expect stores to remain open: We expect that, even if broader shutdowns are mandated in the UK, Pets’ stores will remain open. In France, where wider measures have been implemented, pet stores are included on the list of “essential establishments”, alongside grocers, pharmacies, banks and petrol stations. We would also note that the majority of Pets’ retail stores have a veterinary site located inside, which (intuitively) would seem to further protect against forced closure.
Y20 revenue boost: We called a number of stores yesterday, all of which suggested they have experienced unprecedented demand, with shelves being emptied of larger food bags in particular. Delivery timelines online also appear to have extended significantly. This could provide a noteworthy positive surprise for FY20 numbers (year-end March 2020).
FY21 insulated: We are cognisant of the risks to trading in FY21, particularly relating to whether the recent boost could unwind via consumer de-stocking. However, if customers do eventually feel comfortable carrying less inventory, the impact of de-stocking would likely be spread out over a long period. Furthermore, the business rates holiday should provide the company with cGBP35m of support over the next 12 months. With that in mind, we believe retail could withstand a c5% decline in lfl sales throughout FY21 (versus a run rate of +7-8% over the past 12 months) without consensus estimates changing. This also does not factor in the potential for rent holidays or reductions in the coming months.
Vet business resilient by nature: Pets’ veterinary business should prove resilient by the nature of its services. Listed peer CVS’s lfl sales growth remained positive throughout the 2009 period.
Ryanair etc, upgraded in a sector note from Commerzbank.
We take a fresh view on which company is best suited to weather the Covid-19 crisis. While we see a fairly similar margin impact of six to nine percentage points (LCC’s at the favorable end) on adjusted EBIT in 2020 for all airlines, it will be a lot easier to offset the headwind for the higher margin airlines (Ryanair & IAG). In particular, the reduction in unearned revenues will constitute an additional cash drain for the airlines.
Thus, balance sheet strength is key to not just absorb potential losses but also the cash drain on working capital. Fraport (new Hold, €40) should have seen most of its share decline, with 51% public entity shareholding, it should have a good level of protection and P/B of ~0.65x. We rate Ryanair (€10.25) and IAG (500p) Buy, easyJet (600p) Hold, Air France-KLM (€3.50) and Lufthansa (€6.50) Reduce. The latter two possess a high risk of requiring a highly dilutive state bailout.
Favour low cost carriers over legacies
In times of localisation and ongoing travel bans, particularly the intercontinental traffic is under severe political pressure. Further, business travel has basically come to a standstill which disproportionally affects legacy airlines. Yet, this has not been reflected in current valuation on 2021 forecast. Hence, we change our general preference from legacy to low-cost during this crisis. The solid funding of Ryanair and easyJet should enable them to weather the crisis without state aid as two of the few airlines in Europe.
Cash is king, IAG most solvent legacy carrier
When comparing the three legacy groups, it becomes clear in our view that IAG scores best on all aspects. Not only has it the lowest exposure to Covid-19 hotspots, but it still generates a net profit in our base scenario, and with €9.4bn also the highest liquidity buffer.
Too early to get excited about Fraport, but chance for trough
We alter our rating from Reduce to Hold in this note as the company is now trading at 0.6x book value and the news is out that as of March, the airport will have to face 2-3 grim months before it may get better. We think however that rising ND/EBITDA (peak likely at 6x this year) may bar the stock from rapidly recovering unless there is good news on the pandemic for all.
We prefer financially healthy companies
Especially as we cannot rule out a prolonged crisis, we are looking for financial strength in the sector. In terms of leverage and liquidity, the low cost carriers present a strong picture, in addition to IAG. They could theoretically sustain a total repayment of unearned revenues and still digest some Covid-19 operational losses. Furthermore, we believe that state rescue plans (predominantly) for legacies bear the risk of impairing value for free float shareholders.
Wood Group etc, upgraded in a sector note from Barclays.
Forget 2009–the oil service industry has never faced such pressures, in our view. The simultaneous demand drop caused by COVID-19 has been compounded by a supply battle between major producers. The industry will endure, in our opinion, but it could look considerably different. The typical demand creation of low prices has been halted by unprecedented travel and consumption curtailment, which could give a glimpse at a feasible enviro-utopia–less travel, less consumption, less waste. With it the energy transition is ironically accelerated, in our opinion. Only low-cost energy supplies should be developed and many of the OFS sector’s clients are likely to face existential financial distress. There will still be an active OFS industry, of that we have no doubt. But given that it had barely regained its feet after the 2014 knock-down, this latest punch can only highlight the factors that we think are essential for OFS companies to succeed –robust capital discipline, increased collaboration with clients, accelerated innovation and a transition to green endeavours. In the meantime,our analysis shows that capex could fall as much as 30% and with that fall another round of saving initiatives will likely be required. As in 2009, we see asset-light, well-capitalized, NOC-focused players as the relative winners with backlog being the ultimate defense mechanism at the moment.As such we highlight SBM Offshore (albeit asset light at hold-co level) and Tecnicas Reuindas. We upgrade Aker Solutions, TechnipFMC and Wood to OW while downgrading Tenaris to EW and Hunting to UW. On average we see 66% upside potential for the sector, but with uncertainties around the exact nature of the downturn, and in particular the magnitude of oil demand decline, we adopt a wait and see approach, reducing our Industry View to Neutral
And Alstom etc, upgraded at Goldman Sachs.
We cut our 2021E EBIT by 7% on average across our coverage, now expecting an organic decline in 2020E. Our economists cut global 2020 GDP growth to the lowest level since 2009 but still expect 2021 at 4.8%. In 2009, organic sales growth decreased by 15% (vs. +5% in 2008) and EBIT margins decreased by 100bp yoy on average for companies across our sector. On our new estimates, we see organic sales decreasing 2% (vs. +2% in 2019) and EBIT margins decreasing by 60bp in 2020 vs 2019.
We acknowledge the difficulty in forecasting cyclical businesses in the current environment and look through what a downside scenario could mean if earnings or asset-floor multiples dropped to historical trough. First, we acknowledge our estimates would have >10% downside if prior trough organic growth and margins were to materialize. Second, we conclude the sector would still have c.30-50% downside on average, however Smiths stands out with no downside on any of the three scenarios (P/B through, EV/Sales and through earnings) and Siemens and Rexel, two of our Buy ratings, have no downside on P/B and through earnings.
Still, we see the best opportunity since 2010 to pick single stocks (>25% average sector upside to our PTs). The SXNP is back at July 2016 levels, however the sell-off has been cross-sector and capital goods is not at trough relative P/E to the STOXX 600, increasing the importance of stock picking. To facilitate that, we screen for potential opportunities that have opened up in companies with: (1) strong balance sheets; (2) strong earnings and cash quality fundamentals; (3) where we could see catalysts (e.g. corporate action); (4) depressed valuations; and (5) exposure to secular growth themes (e.g. green capex).
We upgrade Alstom to Buy (from Neutral) and Bodycote to Neutral (from Sell). We reiterate our Buy (on CL) on Volvo. Furthermore, we decrease many of our TPs by between 10-40% as a result of revised GDP forecasts
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