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Broker tips: Halma, Shell, Serco, Provident Financial

By Iain Gilbert

Date: Wednesday 12 Jun 2019

Broker tips: Halma, Shell, Serco, Provident Financial

(Sharecast News) - Analysts at Morgan Stanley raised their target price for Halma's shares on Wednesday but told clients that the current valuation they were sporting was "extreme".
After rolling their estimates forward by a year and taking into account foreign exchange variations and peer multiples, the broker lifted its target on the shares of the safety, health and environmental testing equipment manufacturer's shares by 9% to 1,560.0p.

But despite what it said was the company's "excellent, multi-year track record on execution", the stock was changing hands on 23.6 times' Jefferies's estimate for the firm's financial year 2021 enterprise value-to-earnings before interest and taxes.

Halma was also sporting an estimated 2021 price-to-earnings multiple of roughly 30.8, which was "an all-time high on both an absolute basis and also relative to CapGoods (>100% premium vs 5Y average ~60%)."

According to Morgan Stanley, there was now a risk of multiple compression, although the timing was hard to anticipate.

"We continue to see multiple contraction risk despite a solid earnings outlook but note timing this rotation remains difficult given it appears to be mostly driven by positioning (extreme shift to Quality / Defensives) and macro impacts such as movements on interest rates (strong relationship between falling interest rates and the absolute and relative valuation levels on the defensive names)."

Analysts at Jefferies nudged their target price for Royal Dutch Shell's A shares higher, from 3,000p to 3,050p, telling clients that the company would have to demonstrate its ability to preserve returns even as it invests in its low-carbon businesses, even as they labelled the potential for shareholder returns "compelling".

In its recent strategy update, Shell had de-emphasised upstream as the growth driver, in part as the new Power unit, which had utility rates of return, grew, with deregulated markets and low carbon generation expected to competitive and Marketing and Chemicals generating returns that were seen as competitive with upstream.

"Historically, the Upstream business has provided the highest returns and investors may need proof that Shell can increase its return profile as its growth priorities change," Jefferies said.

"The Upstream business will remain the largest cash generator for Shell and will be allocated about 40% of capital spending - it isn't going away. Nevertheless, we believe that growing the return structure while capital allocation to the Upstream declines as a percentage of overall spend is a key risk for the Shell investment thesis."

Nevertheless, in 2019 Shell's return of cash to shareholders was estimated at 9.6%, 300 basis points more than its closest peer and the visibility provided on its returns "distinguishes the stock and we expect further outperformance."

Under the oil major's current projections and assumptions, which were line-with its own, Jefferies estimated that on top of the $125.0bn distribution potential for 2021-25, Shell would be left with about $120.0bn in discretionary cash flows for debt reduction and shareholder distributions in 2021-25.

Peel Hunt upgraded its stance on Serco shares to 'add' from 'hold' on Wednesday, lifting the price target to 146p from 129p as it highlighted the company's "strategically attractive" acquisition of leading US navy service provider NSBU.

Serco announced last month that it was buying NSBU, for $225m.

"NSBU is a very good fit with Serco's existing business; there is a significant step-up in engineering capability and the US Navy is one of the most attractive segments in Serco's portfolio," the broker said.

It added that the acquisition is a further step in the evolution to Serco becoming a normal company in growth mode.

Peel Hunt also pointed out that the acquisition increases the size of Serco's US defence business by 74%. It said Serco's revenue mix from defence will increase from 30% to around 35% thanks to the deal, and the Americas as a proportion of the group will rise to around 26% from 20%.

The broker upped its pre-tax profit estimate for 2020 by 17% to £123.2m and its estimate for 2021 by 16% to £139m.

Analysts at Canaccord Genuity downgraded shares of Provident Financial from 'hold' to 'sell' on Wednesday, citing downside risks to the British sub-prime lender's earnings per share and dividend payouts.

The Canadian broker highlighted how that at the end of the first quarter, Provident's surplus capital had stood at £60m, versus its desired minimum of £50m.

However, the analysts expected that surplus capital to be whittled down to £51m, £31m and then turn negative by £8m at the end of the next three trading years, respectively, in part as a result of the £20m-worth of exceptional costs incurred in the defence of Non-Standard Finance's hostile bid for the company which had now lapsed.

"Maintaining a surplus of at least £50m is important in the near term for re-negotiating the group's syndicated bank facility maturing in May 2020, according to Provident, which believes that it may be helped by a re-evaluation of its current minimum CET 1 requirement of 25.5% by the PRA to a lower level and/or a release of provisions in Vanquis and Moneybarn, which Canaccord estimates being less than £40m.

Canaccord, which also lowered its target price on Provident from 595p to 430p, noted that if the group's capital position came under pressure, it expected to see Provident's dividends be cut versus its forecasts or even potentially suspended altogether.

"In the most extreme case, if financial performance were to fall materially short of our expectations and in the absence of capital relief materialising, the group may be forced to raise external equity capital to secure its regulatory capital position," added the analysts.

Looking forward, the analysts lowered their adjusted diluted EPS forecast by 4% in 2019 but kept it unchanged in 2020.


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