Broker tips: National Grid, Restaurant Group, SSE, motor insurers

National Grid has a strong investment case as its earnings momentum accelerates and represents a hedge to a reversal of the ‘Trump’ rally, JPMorgan Cazenove said on Friday.

Reiterating its 'overweight' rating, JPM said earnings momentum looked set to accelerate with tariff increases approved recently in the US and 61% of the Gas Distribution sell-down due to complete at the end of the month.

The sale of a second stake of around 14% was in the works too, JPM said, while further tariff increases possible in Massachusetts and Rhode Island this year.

Management plans to return around £4bn once the gas distrubution deal is completed, which is likely to include buybacks of around £1bn and special dividend and share consolidation.

"In our view Grid is an attractive proposition based on fundamentals," analysts wrote, keeping their target price of 1,100p. "In addition, it represents a high quality hedge to a reversal of the ‘Trump’ rally, having underperformed the market 16% LTM."

Unlike its US peers, National Grid’s correlation to 10-year government bonds is high at close to 80%.

Having already updated its forecasts to include the deconsolidation of GD from 1 April, also marking forecasts to market for FX, interest rate and inflation assumptions, the resultant earnings dilution is around 12-13% at net income, but a more modest 1.5% at the earnings per share level on average across the 2017-19 financial years at the EPS level of 65.2p, 65.4p and 68.6, putting the shares on a p/e ratio of 15.5x falling to 14.7x.

Restaurant Group

Berenberg downgraded Restaurant Group to 'sell' from 'hold', keeping the price target at 300p following a strong rally in the shares.

The bank highlighted the fact the stock is up around 23% since the end of January, adding that the current valuation is unattractive.

It noted the company's weak set of 2016 results and said that while management's plan to turn the business around was laid out in fairly considerable detail, it has not changed the bank's view that the group has a very tough task ahead, considering the extent of the changes that need to be made to the leisure brands.

Berenberg said the plan to try to improve the performance of the leisure brands, which includes menu changes, pricing correction, improved labour scheduling and increased marketing, seems sensible.

However, the bank's analysis suggests significant price correction is required to bring these brands in line with competitors.

"We continue to believe it could take considerable time for the brands’ reputations to improve sufficiently for volume growth to offset lower prices. As a result, we anticipate that like-for-like sales will decline 4.5% this year, and we feel that there is risk to achieving this figure."

Berenberg added that given the way the competitive landscape has evolved in recent years, it is difficult to have confidence that the strategy will lead to a strong recovery.

The bank cut its price target on Domino's Pizza to 400p from 425p, keeping the recommendation at 'buy' as it reduces its earnings per share estimates slightly to account for the purchase of a loss-making business in Norway.

SSE

Analysts at HSBC have downgraded SSE, saying potential tariff caps enforced by the government could weigh on the energy supplier’s performance.

The FTSE 100 utility was downgraded to ‘hold’ from ‘buy’ and its target price was slashed to 1,620p from 1,740p on a higher risk premium.

The bank believes that the political ‘noise’ surrounding energy prices is growing louder, as SSE and the other big six energy suppliers - bar Centrica - are set to hike prices. SSE is upping its prices for domestic customers from 1 April by 6.9%, or £73 per year.

In response, Prime Minister Theresa May said on 17 March that the government is considering how to “step in” to control energy prices because the market is “manifestly not working” for consumers and it will aim to “crack down” on businesses that “abuse the system”, according to the Telegraph.

HSBC modeled SSE’s earnings per share with a price cap which implied a circa 9% earnings per share erosion in 2018 and an increase in the dividend payout ratio to 94% from 85%.

It also found that in terms of credit ratios, SSE would remain within the stable A3 rating from credit rating agency Moody’s, even with a tariff cap and said that it is this, not the dividend cover that underpins the retail price index-linked dividend policy.

“Our major concern with recent developments is that the rating agencies will see any government intervention as an increase in the risk profile of the UK integrated electric utilities and increase the risk premium which may include higher key credit ratio requirements. The utilities could then face a cash constraint which might impede their ability to grow dividends,” HSBC said.

SSE’s recent third quarter trading statement reiterated its 2017 target of achieving adjusted earnings per share of at least 120p and updated its capital investment programme for 2016/17 financial year to be about £1.75bn.

HSBC said it was difficult to see how “any earnings upside will compensate for concerns about political risk or how the stock will outperform with the current levels of uncertainty”.

Motor Insurers

UBS adjusted its ratings on UK motor insurers on Friday to reflect changes to the Ogden discount rate used to calculate lump sum payouts for personal injury claims, which was recently cut to -0.75% from 2.5%.

The bank said the reduction ensures primary motor insurers need to increase prices substantially to maintain margins.

"Insurers with lower reinsurance retentions can hold off price increases for longer and take market share in the meantime. As such, our preferred exposures in the sub-sector are those with attractive valuations, strong franchises and lower reinsurance retentions – namely Direct Line, Saga and Hastings."

The bank added that they can afford to delay price increases without adverse margin impact at the expense of those with higher retentions, such as Admiral, Aviva and AXA.

UBS estimates that price hikes of around 15% are needed for UK insurers to offset the impact of the Ogden change and claims inflation.

The bank upped is stance on Direct Line to 'buy' from 'neutral' and RSA Insurance to 'neutral' from 'sell'. It cut Admiral to 'neutral' fro 'buy' and initiated coverage of Hastings at 'buy' and Esure at 'neutral'.

"The market is pricing in a significant deterioration in Hastings' margins but given reinsurance protection over the next 12 months and unchanged risk tolerance, we see that as unlikely."

As far as Esure is concerned, it said the growth profile is attractive, but coming from underwriting new segments, which presents some risk.