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Markets Now – Wednesday 15th April 2020

One of the footnotes to 2020 Greater Depression Wiki will relate to how the insurance industry and its investors guessed immediately that an unprecedented catastrophe would probably not need to be classified as a catastrophe event. Sure, okay, it might be true that at least one of the Four Horsemen has just turned up. But with insurers it’s all about the small print, and the wording of standard contracts doesn’t tend to have an explicit clause to cover Book of Revelations eschatology.

SME insurers Beazley and Hiscox started the week down just 28 per cent in the year to date, which was not much worse than the broader market. They’re now doing rather worse even after a flood of bad press, and in spite of a “dear CEO” letter this morning from the FCA clarifying that purchasers of business interruption insurance should not have expected to be insured against business interruption.

Based on its conversations with the industry to date, most policies have basic cover that doesn’t cover pandemics so there’s no obligation to pay out, the FCA says. While this may be disappointing for the policyholder, the regulator “does not see reasonable grounds to intervene in such circumstances”. There follows a bit of pass-agg parenting: 

… However, it is important that claims are assessed and settled quickly where there are policies where it is clear that the firm has an obligation to pay out on a policy. The FCA expects insurers to pay claims quickly and to make an interim payment if there are reasonable grounds to pay part of a claim, but not it in full. If you disagree with doing so , we would like you to send to us the grounds for reaching that decision including how you believe it represents a fair outcome for customers. Your firm’s decision is likely to help inform our assessment of its culture.

Hooray, says JP Morgan Caz:

[O]verall we see this as a reassuring message to the UK insurance industry. We note other geographies (in particular the US) are likely to see wording subject to significant legal challenges and therefore we believe this is a topic that will not quickly be resolved, but nevertheless it is encouraging from the insurance industry’s perspective that the regulator appears to agree with their view of potential exposure.

In our view the view of the FCA aligns with that of the insurance industry, however where there may be more difficulty is in grey areas, where pandemic cover is not explicitly excluded. There are several cases in the US that are attempting to claim in such circumstances, or even where pandemic cover is excluded, and while we would not expect these to be successful (the intention of the wording was generally not to provide cover in our view), the market has rightly identified it as a possible risk. In our view retrospectively applied cover across the board is not something that the insurance industry has the capital to accommodate, nor was it priced for or included in risk management approaches. In our view such a ruling would have severe implications not only for the financial stability of the sector, but also for its ability to price risks in future – for this reason we do not see it as likely.

Of course, refusing to pay out isn’t a good look for the likes of Hiscox (“we never look for loopholes”). The big question relates to whether the exposure is big enough to wear the unpopularity. Here’s UBS:

We see this as more of a risk to non-US property lines at this point given business interruption coverage for pandemic is low in the US. Across our coverage, we estimate non-US commercial property exposures comprise ~15% of P&C premium, with exposure for the London Market (~20% of premium) reinsurers (~18%, although we see this BI issue as more of a primary event), UK P&C (~14% of premium), and then the multilines (~10%). The key determinant of (re)insurer exposures will be company specific policy wordings, where visibility is low. … Based on company commentary so far, we still believe potential COVID-19 claims (including BI) are a manageable P&L event for the sector, although the devil will be in the detail when it comes to BI policy wordings. On this point, having read the Hiscox UK SME policy wordings, we do believe risks to the shares have increased given some grey areas. That said, yesterday’s share price move discounts significant risk. We remain Neutral and believe it too early to take a stance until we get detail on potential UK SME exposures, sub-limits and scope for reinsurance protection.

And RBC with some numbers:

If we assume that UK SME policyholders make up a similar share of customer numbers as they do premium, this could suggest customer numbers around 80-100k that could potentially have some sort of exposure. In reality, a far smaller number of policyholders would have seen their businesses impacted. We believe that the vast majority of Hiscox SME cover is provided for white collar companies that would not rely on premises to do business and therefore would not need to claim. Policy limits were said by [an] Insurance Insider article to be around £100k.

For the broader picture, Peel Hunt:

We estimate that up to 36% of HSX’s premiums could be exposed to the fallout of the Covid-19 pandemic, with direct (eg, event cancellation insurance) and secondary effects (business interruption, liability) fuelling claims activity. We believe claims could emerge across the retail and London market businesses, with re-insurance being more insulated.

Hiscox’s retail business (50% premiums) may be more sensitive to the political risk engulfing the insurance sector. Around 80% of retail premiums are exposed to commercial SMEs and micro businesses, predominantly in the US and UK.

Retail includes commercial property and liability exposures, which includes business interruption and general liability cover. So, the accumulation of losses across the retail book could be material, particularly if governments force insurers to relax the terms & conditions of Covid-19-exposed insurance contracts.

Taking a central Covid-19 scenario, we believe claims could reach cUS$260m in 2020E (within a range of US$80m in a low risk and US$530m in a worst case), equivalent to a CoR of 105%; including our credit default assumption, this accounts for 14% of TNAV. Whilst this is material, it is an event risk HSX is prepared for and has set aside capital to absorb. Thus, we estimate the HSX solvency position should be sufficiently robust to deal with this.

Based on our central scenario, we lower our 2020E adjusted PBT from US$203m to a small US$32m loss (-10c adjusted EPS). This brings down our 2020E TNAV by 3% (including a cut in the DPS) to 666c per share (537p), and we expect the adjusted RTNAV to be -1.5%. Our 2021/22E adjusted PBT declines by 15%/9% respectively. On the back of these cuts, we lower our target price from 1,030p to 800p. We retain our Reduce stance given the downside risks to earnings, but we believe HSX has the capital to absorb a worst-case scenario.

All’s still fine over in motor insurance, with customers clearly delighted to pay higher premiums for parked cars. Hastings is leading the FTSE 250 gainers on an in-line Q1 and maintained dividend. Industry repair costs are still going up but accident frequency has fallen since March, unsurprisingly, with pricing trends remaining stable. Here’s Goldman to summarise the rest:

Hastings has also stated that it still intends to pay its final 2019 dividend of 5.5p, noting a conservative investment portfolio and limited COVID-19 insurance exposure. The solvency ratio of the group’s insurance entity is expected to remain within the 140-160% target range. Hastings is taking a number of actions to provide targeted support to customers, such as free RAC break down cover for NHS and care workers.

Overall, we believe this update from Hastings points to robust operational performance and stable UK motor market conditions. The benefits of prioritising the dividend over debt reduction are likely to be finely balanced, in our view, but note the positive signaling effect regarding financial strength. We note also the steps taken by Hastings to support certain customer groups; we believe it is important that UK motor insurers take early action on reinvesting potential benefits from lower motor loss frequency to avoid regulatory/political steps being taken to stem excess profitability, as observed in some US states. 

Also worth noting before we leave insurance is Chesnara, the UK run-off specialist, which has said it’s still paying its 2019 dividend in spite of the regulatory guidance to pause. Potentially significant for its sort-of peers? Maybe, says Morgan Stanley:

While we recognise that continuing with dividend payments is a decision for individual boards, this could be a positive sign that other UK life names that haven’t commented since the PRA / EIOPA announcements might go ahead (such as M&G).

Wider market’s continuing to square off the idea of first-wave death tolls topping out and lockdowns continuing indefinitely. Brent’s at $28 a barrel, down 4 per cent, and sterling’s off about 1 per cent at $1.25. Stocks, other than those delivering food, are clawing back some of a five-day rally awaiting America’s earnings season to get going properly.

There’s nothing much in European corporate to get excited about and oil was covered excessively on Tuesday so instead, here, have some sellside.

JP Morgan has an upgrade of Asos. “What doesn’t kill you makes you stronger,” it’s called, which isn’t medical consensus.

Asos has had a turbulent 18 months. Even ahead of the COVID-19 crisis, but as recently as nine months ago, fast paced expansion and a lack of management bandwidth combined to cause creative missteps, warehouse issues and, ultimately, slowing demand and lower profitability. However, roll-forward and the group has significantly strengthened the board, addressed mistakes with tangible changes resulting in re-engagement of demand, but also overall better operational grip than we have ever seen at the company – as highlighted by improved results and KPIs over a now 6- month period. Separately, the recent capital raise provides sufficient funds for Asos to manage through this crisis, and indeed could well leave the balance sheet in a more robust position even as we exit the crisis period. In summary, we believe navigating through recent challenges has created a stronger Asos, and we upgrade to OW from N (DCF-based PT lowered from 3,800p to 3,500p, end date rolled forward 1-year to Aug-21).

… In our view, a stronger operational grip has now been consistently demonstrated. The most tangible outputs from this are cost efficiencies (for example, payroll and marketing savings of c.£44m and c.£16m p.a. respectively, and distribution cost leverage through simple measures to drive ABV). However, improved processes and controls are visible throughout the business, from clearer guidelines across buying & merchandising teams, through to weekly KPIs assessments in granular detail and with clear accountability. This stronger foundation should be supported through 2020 as management bandwidth improves further (with only one remaining C-suite role to be filled).

We appreciate that our timing is less than ideal with the stock +82% over the last week, having bounced from recent lows ahead of raising capital. However, even post this bounce Asos has underperformed ecommerce peers by almost 20%, and is on average down broadly in-line with our coverage. This is despite underlying upgrades (had the COVID-19 crisis not occurred, following these results we would have been raising our forecasts by c.30% for FY 20 to FY 22), further evidence of underlying improvements in the business, a smaller impact on the topline than for most discretionary retailers, and liquidity now having been supported. Overall therefore, whilst we expect a bumpy road ahead for the sector over the coming months … we place Asos at the top of our OW list.

Barclays has turned positive on a bunch of Reit stocks including Hammerson. Here’s the thinking:

Given the almost impossible task of predicting the unpredictable, we have prudently aimed in our model updates to reflect cautious assumptions without becoming reactionary. … To frame our assumption changes, our base case regarding the above three points are: 1) the pandemic and lockdown impacts last for three to six months from the beginning of March; 2) the pandemic effects will drive a material reduction in economic and social activity which will be felt past termination of the various lockdowns across Europe, thereby rendering the entirety of 2020 as a write-off; and 3) while we then believe life returns to a semblance of normality, we do not believe, in economic terms, we automatically revert back to levels seen pre-COVID-19, and therefore negative effects relative to prior published forecasts will likely continue to be experienced into 2021 and beyond.

We expect, and make,the following general changes across our coverage relative to prior assumptions:

1.Any growth (either LFL rent, market rent or yield compression) is likely to be deferred for 18-24 months. We, therefore, as a base case forecast 0% ERV change and remove any prior assumed yield compression over this time period. Note there will be slight differences between similar companies and larger differences between sub-sectors. These changes negatively impact asset valuations and rental growth which negatively affects future EPS. From 2022 we generally revert back to prior assumed ERV growth, LFL rental growth and yield compression.

2.Non-committed developments deferred; income from committed developments delayed by 6mths and developments incur a 10% increase in remaining CAPEX. We reduce acquisitions and disposals in 2020 with a pick-up thereafter.

3.A specific impact on rental income in 2020 and a smaller impact in 2021. The quantum of the effect varies by sub-sector and, importantly, we do not expect this to negatively affect valuations. This measure is an attempt to cover a multitude of factors, all of which are, at present, unquantifiable, and include a combination of: 1) rent deferrals (a number of which may not bere paid); 2) rent withdrawals; and 3) tenant defaults. We apply similar reductions to companies in similar sub-sectors,and while the absolute quantum may be wrong, we believe the relative impact will be broadly accurate.

4.Include slight yield expansion in 2020, which is broadly unwound over 2021/22E for all sub-sectors except retail.

Divi policy changes, debt financing costs and risk premia are also adjusted. Then there’s the sub sector stuff on Gross Rental Income (GRI) to account for rent deferred and waived in 2020:

We believe this negative effect on rents will be much larger than valuation declines. As the specific impact from COVID-19 is impossible to quantify at this stage, especially on a stock-specific basis, we use this additional GRI impact to reflect a relative effect for each sub-sectorr ather than by company: Logistics/Industrial -5%,Offices -10%, Retail and Hotels -25%, Residential and UK Healthcare 0%, European Healthcare -3% and Student Housing -30%. We expect this negative COVID-19 effect to be largely unwound over 2021/22 for all sub-sectors except Retail. However, we are cautiously not assuming, at this stage, that any waived/deferred rent in 2020 is recovered in the future –i.e. 2021/22 rent returns to agreed lease levels rather than higher levels as we believe tenants will struggle to pay the additional (deferred) rent in the future

Based on that framework were are about a dozen changes, as detailed:

We reduce forecasts but upgrade to OW three retail-exposed stocks that have materially underperformed the EPRA Index YTD: Hammerson (PT 115p, from UW), Landsec (PT 745p, from UW), and Merlin (PT €10.0, from EW). While TARs remain anemic for these stocks and therefore the upgrades go against our successful pure-TAR-based approach, we believe these companies have been too aggressively sold down in the COVID-19 market collapse. We consider these stocks relatively attractive at current levels.

Also within retail we cut estimates for Klepierre and downgrade to UW (PT €18.0, from EW) given its material outperformance vs. other retail-exposed stocks YTD.

We also upgrade Gecina to OW (PT €150, from EW) and downgrade Colonial to UW (PT €8.0, from OW). We prefer 100% Paris exposure over Spain as we believe, at this stage, the historically heightened cyclical nature of Spanish offices more difficult to call in current markets and prefer the historically more stable Paris office market. More generally we see increased near-term risk to Colonial’s low-yielding office exposure given it requires capital growth to drive high TARs.

To ensure our coverage remains balanced,and although we continue to see upside to our PTs,we downgrade Fabege (PT SEK 140, to EW from OW) and Entra (PT NOK 135, to UW from OW). Each stock offers exposure to lower-yielding offices as we have lowered LFL capital growth and development expectations we forecast they will generate lower relative TAR. Furthermore, they have outperformed the EPRA Index YTD.

We reiterate OW ratings on Unite (PT -19% to 1,065p), Aroundtown (PT -23% to €6.5) and Covivio (PT -29% to €75.0). The stocks have materially underperformed due to the operational impact of COVID-19 and/or concerns around leverage levels. We believe investors should look beyond 2020 and focus on medium-term fundamentals as student housing and hotels remain attractive asset classes. We reiterate OW ratings for office exposure on Kungsleden (PT -23% to SEK 100), Castellum (PT -15% to SEK 200) and Alstria (PT -15% to €16.2). While these stocks have either outperformed or performed in line with the EPRA Index YTD, we continue find these stocks attractive owing to the higher-income component of the TARs for Kungsleden and Castellum and for Alstriain its combined slightly higher income return and materially lower leverage. We reiterate OW rating on Segro (PT -8% to 900p), given our view Logistics will be a beneficiary of the accelerated structural trend of online sales, especially in Continental Europe. Finally, we reiterate ratings within the Healthcare sub-sector–OW on Assura (PT +5% to85p) and PHP (PT +1% to 170p)as we continue to highly rate the security of income,and UW on Aedifica (PT -20% to €80) and Cofinimmo (PT -11% to €111) as we see heightened risks to the groups’ care home operators as a result of COVID-19.

Phew.

Bernstein’s knife catching both Diageo and Carlsberg. Relative underperformance against the sector “can be explained by the combination of the significant drag that European Beverages faces due to the lockdowns that are in place around the world,” Bernstein says. “However, LT, we expect that consumers’ desire to socialize using alcohol as a lubricant has not changed, even if we may possibly see some changes in how consumers socialize.”

The challenge for valuation is estimating market earnings expectations. We like to think we have largely kitchen-sinked our models. But consensus estimates for both European Beverage and the broader market still appear to us to be massively out of date. Only 40% of analyst have downgraded estimates in IBES so far! We base our valuation calculations on our own estimates for European Beverages and follow the best estimates of our strategist Inigo Fraser-Jenkins that estimates for the MSCI Europe need to fall an incremental approx 30% for 2020 and 6% for 2021. This puts the sector on a relative P/E premium of 35% on NTM+1 (Apr 21-Mar 22), 16.2x for Beverages vs 12.0x for the Market. We think this 35% is too low compared to our belief that 50% is warranted in the long-term.

Within European Beverages, Carlsberg and Diageo are at broadly fair multiples relative to peers but in a sector which is now undervalued; hence, we upgrade to Outperform, with 22% and 17% potential upsides respectively. Rémy Cointreau has been amazingly strong since 2nd Mar, rising 9% as the market crashed. As a result, it is now trading at a 65% premium to peers, compared to a LT average of 40% and our target premium of ~30%+. Hence we downgrade to Market-Perform, with an unchanged target price of €100.

Citi downgrades AB Foods and Marks & Spencer in a retail note.

Our analysis suggests there is limited liquidity risk under our base case with all companies having sufficient funds to last until trading is forecast to normalize in September. However, we believe that after a period of released pent-up demand, the reality of the economic situation will dawn and consumption will be held back by lower consumer confidence and higher unemployment. The V-shaped recovery in consumer spending feels too bullish in our view. In the short term the global stimulus packages combined with more positive newsflow on COVID-19 cases, vaccines and lockdown restrictions easing may see shares trade higher, but we fail to see this supported by fundamentals.

Initial fears over supply shortages have been superseded by the short-term impact of store closures; mid-term fear of inventory overhang and fundamental demand; and longer-term questions on structural shifts. The impact of store closures has been quickly priced in (albeit we think the negative leverage and stock markdown may be higher than expected), but there is an underlying assumption of a return to “normal by September” based on extrapolation from China and continued online demand. In our view there will be a quicker recovery in confidence for younger consumers, but less so for older consumers (who carry a larger proportion of discretionary spending power) and online penetration will take a noticeable step up. These trends do not favour M&S or Primark.

We reduce our sales growth to -7.5% yoy in CY20 (from +0.4%), with a recovery to +5.9% yoy in CY21 (from +3.4%). This drives EPS downgrades of -24% for CY20e, after the benefits of mitigation, and leaves CY21e EPS c.-23% below our previous forecasts after the 2021 recovery.

We downgrade AB Foods and M&S to Neutral from Buy and upgrade Dunelm to Neutral from Sell. Consensus earnings are likely to continue falling as further datapoints are reported. Looking at recovered 2021 PE still delivers relatively limited upside v recent history for most names.

And RBC are sellers of Rightmove. GfK’s consumer confidence index in March hit its lowest since the financial crisis and sentiment across the housing market has deteriorated sharply, which aren’t great signals for longer term transaction volumes, it says: 

Rightmove’s defensive business model and attractive cash flow characteristics have warranted a historical 60% PE premium to the market. Currently, however, we do not believe the shares are appropriately discounting the risk of prolonged pressure on the property market, and in turn on Rightmove’s customers. Our PT falls to 440p (from 550p) on lowered estimates, implying 13% downside; move to Underperform.

The likelihood of the immediate, sharp impact on the property market from COVID-19 extending into a drawn-out period of weakness has increased, in our view. As such, we expect an acceleration in estate agent closures and greater pressure on Rightmove’s ARPA (Average Revenue per Agent) near term. Our FY20/21e EBIT falls by 52%/17%. …

Rightmove’s pricing power may be undermined by a downturn. RMV’s ARPA has increased almost 4x in the last 10 years and now represents c.5% of an agent’s revenue (compared to c.3% for Scout24). In recent years, like-for-like price inflation has also outpaced peers at 4-5%, compared to e.g. 2-3% for Auto Trader. We are concerned that this degree of price rises may not be sustained going forward, particularly in light of the negative press coverage Rightmove continues to receive from disgruntled agents and more aggressive competition from #2 player Zoopla. The COVID-19 crisis may act as a catalyst forcing agents out of business and undermining Rightmove’s ability to resume annual 7-10% price rises in the future.

We cut our FY20e revenue by 41% as we assume a discount extension of two months and a 6% decline in the number of advertisers (from -1%) on Rightmove. This compares to a 13% fall during the 2008-09 financial crisis. Our bear case implies an extra 50% cut to EBIT assuming extension of the discount offer until year-end and a 10% fall in advertisers. Even in this case, Rightmove remains in a net cash position.

DCF-derived PT of 440p implies FY21e EV/EBITDA in line with history. On our lowered estimates, RMV trades on 20x FY21e EV/EBITDA, a 15% premium to history. On our recessionary FY20 estimates, the shares trade on 38x FY20e EV/EBITDA, a 120% premium to history.

• Updates to follow. Requests, complaints and so on can go in the comment box. For FTAV unfiltered, the Telegram Markets Live chat group offers crowdsourced moment-by-moment commentary.


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