Broker tips: Imagination Technologies, Babcock, Sainsbury's

Imagination Technologies shares fell on Thursday after Numis downgraded the stock to ‘add’ from ‘buy’ after the company sold its Pure digital radio business.

The group, which designs chips for iPhones, sold Pure to Austria’s AVenture AT for £2.6m in cash as it looks to reduce debt. The deal also grants the buyer an option to buy one of Imagination’s properties in Kings Langley, Hertfordshire, for £4.5m.

“The consideration for the Pure business is a little less than expectations, which were in the £5-10m range, however the delta is somewhat immaterial,” said Numis.

“The Pure business had been classified as for sale by the new management team as it had been consistently loss making.”

Imagination made the announcement about the sale as it reported its first quarter trading update. The company said the performance of its continuing operations in the first quarter continues to be in line with the board’s expectations.

Numis said its rating downgrade reflects the recent rally in the stock, amid speculation that the company could be next up for grabs after Softbank agreed to buy ARM Holdings for £24bn in August. The broker raised its target price to 280p from 220p.

“The stock has rallied strongly in recent months, with the acquisition of ARM by Softbank the main identifiable catalyst, increasing focus on the strategic value of the PowerVR graphics business (which is a key strategic technology used by Apple)."

Babcock International has seen a slower performance in the first half but still expects to grow revenues 6% in the full year, broker Shore Capital revealed as it reiterated a 'buy' recommendation on the engineering services outsourcer.

With Babcock's shares feeling some effect of the sector turmoil around fellow outsourcer Capita's profit warning on Wednesday, ShoreCap's note after a catch-up with the company's finance director Franco Martinelli was timely, with the company having not issued a trading update since July.

Babcock, "in the round", has performed in line with expectations, retaining organic revenue growth guidance in the 6% range for the full year but expecting performance to be slightly weighted to the second half.

"This is principally due to slower than anticipated conditions in South Africa operations and with oil services related contracts in MCS (helicopters) due to commence in H2. South Africa operations (those mainly in power related activities) are expected to improve in H2," explained analyst Robin Speakman.

"We sense that Babcock remain broadly positive on the environment and the medium to long term outlook," he added, with the company’s order book remaining stable and indicated to remain at a similar level to the circa-£20bn last reported at the final results in May.

The pipeline was reported to have remained stable, with contract opportunities expected by Speakman "to begin to lift the pipeline early next year", with no further news on the award of the Defence Fire Risk Management Organisation contract with the Ministry of Defence for fire services management - also being bid by Serco and Capita.

HSBC has reiterated a ‘reduce’ rating and target price of 185p on Sainsbury's after the supermarket reported a drop in second quarter sales.

The supermarket group, which is now also a major general merchandise retailer after completing the acquisition of Home Retail Group's Argos on 2 September, revealed on Wednesday that total retail sales fell 0.4% in the 16 weeks to 24 September, with like-for-like retail sales including VAT but excluding fuel down 1.1%.

Sainsbury's blamed industry-wide falling food prices for the decline in sales.

“ADI (Adverse Differential Inflation: cost inflation is higher than selling inflation) is a problem for any company, but is a particular problem for a company with declining sales and facing intensifying price competition,” HSBC said.

“The industry is in the midst of the deepest and longest period of ADI in recent history and there is no sign this will end soon. Management says it is pleased with progress against its business plan, but that plan includes expected on-going decline in the core estate and with high operational gearing, this is worrying to us.”

HSBC added that it believes Sainsbury’s “lacks the scale” of Tesco and has a weaker balance sheet than Morrisons.

The bank also remains “unconvinced by the Argos deal and view it as a major distraction and management drain at a crucial time”.

Sainsbury’s plans to open another 15 Argos in its stores by Christmas, taking the total to 30, and to have 200 collection centres by the year end.

“We would also question would Sainsbury have opted to buy this company if they had known we would be heading for Brexit and the exchange rate would depreciate?" HSBC said.

“There may be some protection from short-term hedging but the long-term problem of rising costs is not going to go away – especially if consumer spending slows.”

HSBC expects Tesco will become more aggressive in the fourth quarter and the current equilibrium will be upset.

With a weak balance sheet, high operational gearing and the distraction of integrating Argos, Sainsbury looks vulnerable to intensifying competition, the bank said.