Broker tips: ABF, Poundland, Diageo

UBS downgraded Associated British Foods to ‘neutral’ from ‘buy’ and removed the stock from its ‘key call’ list, saying the valuation now reflects near-term US upside, but raised the price target to 3,180p from 3,050p as it rolls forward its estimates.

It said the success of Primark's upcoming US entry is critical to the current investment thesis, adding that with near-term cyclical challenges such as gross margin pressure and operational challenges in Sugar, the risk/reward is balanced.

With Primark's entry into the US imminent, UBS took a look at potential scenarios around the openings.

The bank’s upside scenario, based on Primark's successful roll-out in Germany, suggests US sales could reach £345m by year 7, with a 1% market share, or around 15% of the current market cap. It said that should the US entry prove unsuccessful, there is limited downside.

“We estimate exit costs of less than 1% of the market cap, given the leasehold nature of the agreements, and hence the US opportunity is a risk worth taking in our view.”

UBS said the fundamental attractions of Primark remain, with the brand still relatively underpenetrated in Europe.

Ahead of a regulatory ruling on whether Poundland can complete its acquisition of rival 99p Stores, Jefferies has upgraded the company to 'buy' from 'underperform' and hiked its target price to 400p from 260p.

In “mid to late August” the Competition and Markets Authority is scheduled to issue its provisional findings and, if required, its possible remedies on the proposed acquisition.

Jefferies said it expected the CMA's provisional findings statement will lead to a re-rating of Poundland's shares in anticipation of a deal being concluded.

It calculated that, even if the CMA reiterates its strict definition of Poundland's competitors they may relax their view on potential competitor store openings, Poundland is likely to acquire at least 170 of the 99p stores.

"We believe in the worst case Poundland will have to divest 80 99p stores, as suggested in Phase I, and more likely fewer. In our base case deal scenario we assume Poundland can keep 200 99p stores."

The broker's consumer research has suggested "revenue synergies will be limited" but the potential cost savings make the deal worthwhile, with buying and cost savings of £15-£20m, which leads to a 30% increase in Jefferies' below-consensus 2017 earnigns per share forecast to 13.75p.

Even so, Jefferies noted that "as details of a potential deal unfold we expect to be more bearish than consensus".

Also it added: "Valuing Poundland ahead of the CMA's decision is tricky. We believe that the stock can rally back to 400p assuming the CMA's findings are no worse than in April. But then investor focus may switch to Poundland's rapid saturation of its core UK market. We recommend buying for the initial upside."

Analysts at Investec upped their rating for Diageo to ‘buy’ from ‘hold’, and said a “change story” was underway.

Investec raised its price target for the stock to 2070p from 1860p.

In a note to investors, Investec said drinks maker Diageo was at an inflection point, and was in a good place to capture “premiumising” trends.

Investec raised its group organic sales growth forecasts from financial year 2017 to 5.8% from 5.1%.

Analysts said Diageo just needed to market better to the millennial, and an overhaul of its approach should reinvigorate share growth.

Investec said the company had room to growth in the North American market.

“While we are certainly encouraged by recent signs of stabilisation in Diageo’s emerging market businesses, the crux of our more bullish stance is the potential for improvement within its key US spirits business,” analysts said.

Despite press reports of bid interest from Brazilian firm 3G capital, Investec said it was skeptical Diageo was a legitimate target.