Broker tips: Centrica, IMI, Tate and Lyle, Greene King
While Centrica shares had been in value territory for the last six months, analysts at Jefferies now see potential for "material earnings upgrades" from the British Gas owner as a result of the recent rally in energy prices and a regulatory shift.
The broker had remained on the sidelines over the shares in recent months due to subdued earnings momentum, but on Tuesday it highlighted the recent rally in power, gas and oil prices and the revelations from Ofgem's recent consultation which suggested that there is "unlikely" to be a highly punitive standard variable tariff price cap outcome, given that the primary focus of the cap is the protection of SVT customers.
Even with a £1,110 SVT price cap for direct debit customers, Jefferies still expects Centrica to continue to generate more than £2.1bn of adjusted operating cash flow per year.
Analysts also noted that Centrica's ability to strengthen its balance sheet and crystallise value with disposals "remains underappreciated".
The analysts think both the sale of Centrica's 20% stake in EDF Energy and divestment of Spirit Energy at valuations of £1bn and £1.9bn respectively would strengthen Centrica's balance sheet and crystallise value for shareholders.
All in all, the analysts raised their target price on Centrica from 140p to 165p and upgraded the firm from 'hold' to 'buy'.
IMI's shares have derated too far, said Morgan Stanley on Tuesday, upgrading the engineer to 'overweight' on potential for a 20% gain.
The derating has mainly been driven by concerns on power generation, with fossil fuel accounting for 12% of group EBIT but recent work by the investment bank's analysts suggesting gas markets "could be close to trough".
IMI's service business "is attractive" with a 6% sales compound annual growth rate since 2008, with Critical engineering later-cycle than some UK peers, the capex in Process engineering "should be a tailwind in 2019" and valve pricing "also improving".
Returns are "not sufficiently priced in", with IMI's return on capital expenditure averaging 27.7% between 2007-17 compared to average UK engineers at 20.6% "and we expect this outperformance to persist".
So the derating has provided "one of the best entry points" in eight years, analysts said, advocating clients rotate out of prior top pick Rotork into IMI, for which the price target was hiked to 1,410p from 1,180p.
Kepler Cheuvreux downgraded Tate & Lyle to 'reduce' from 'buy' and cut the price target to 620p from 630p as it looked to lock in profits since its upgrade of the stock.
The bank cited doubts about Tate's ability to beat peak-year 2017/18 in terms of operating performance as the main reason for its change of stance.
"Although we expect the current year to be quite similar EBIT-wise, we see big downside risks to the Sucralose and commodities businesses (together circa 30% EBIT) from 2019/20E onwards. We think the market misunderstands the dynamics there, and we are 10% below consensus EBIT numbers for 2019/20E and 15% for 2020/21E."
Kepler said that at 15x estimate 2019/20 price-to-earnings, the stock is no longer cheap.
"A price-to-earnings comparison with main peer Ingredion shows a 20-25%+ premium for Tate & Lyle. Based on our estimates, investors are already willing to pay for the potential of M&A/buybacks. Given the focus on operational performance in Tate’s remuneration policies, we do not believe a big buyback is likely.
"On M&A, we have our reservations regarding potential for value creation, given the transaction multiples seen in the sector."
Greene King will be the leisure sector's biggest winner if England do well in the FIFA World Cup while Restaurant Group and Mitchells and Butlers are likely to fare worst, according to Berenberg analysts.
After talking to management at companies they cover, the Berenberg leisure team found most businesses planning for England to play four matches, going out in the first knockout phase.
A company with 100% football-based pubs would gain at least three trading days under this scenario as fans drink and eat while watching England games, which kick off on 18 June, the analysts said.
No company is that football oriented but Greene King, which makes a feature of football across its managed pubs, would be the biggest gainer. Berenberg has a ‘sell’ rating on Greene King and recommends investors sell the shares on any World Cup-inspired gains. City Pub Company, Fuller’s, JD Wetherspoon and, to a lesser extent, Marston’s should also benefit along with Domino’s Pizza.
Restaurant Group and Mitchells and Butlers, which focus on casual dining, are most vulnerable to consumers opting for drink-led pubs or takeaways at home, Berenberg said. Cineworld and bowling operators Hollywood Bowl and Ten Entertainment are also potential losers though only about 15% of Cineworld’s business is in the UK after a recent US acquisition. The bowling companies do not report quarterly data and can spread the impact over a longer period, the analysts added.