Broker tips: Sainsbury, Diageo, Metro Bank

Goldman Sachs removed Sainsbury from its ‘conviction sell’ list, keeping at ‘sell’, with a 195p price target.

The bank noted Sainsbury has significantly underperformed UK peers years-to-date, down 6% versus Morrison up 55% and Tesco up 41%.

“Though we remain bearish on the stock, there is no longer more downside to our target price versus other stocks in our coverage. We therefore remove the stock from the conviction list, but with 20% downside we remain sell rated.”

Since being added to the conviction list back on 18 January, 2013, the shares are down 25.6% versus the FTSE World Europe up 25%, due to structural UK grocery market pressures which manifested over the period, GS said.

Goldman said Sainsbury remains the stock it is most bearish on when it comes to risks to earnings estimates.

The bank pointed out that in the food business, it has consistently argued that EBITDAR margins around 100-150 basis points ahead of Morrison and Tesco UK is sustainable, particularly in the context of them driving like-for-like volume growth well ahead of Sainsbury for the first time in over five years.

“We believe further price and/or offer investment will be required to reverse this trend and therefore forecast grocery EBIT margins falling 119 bp FY16-20.”

In addition, it highlighted Sainsbury’s recent acquisition of Argos. GS said that although there are clear synergies from optimising the Argos and Sainsbury store footprints, over the next two years as hedges roll off, the exposure to the US dollar on purchasing at Argos will be a major profitability headwind.

Sainsbury is scheduled to release its first-half earnings on 9 November and Goldman expects to see underlying group EBIT of £316m, down from £366m in the first half a year ago.

HSBC upgraded Diageo to ‘buy’ from ‘hold’ and lifted the price target to 2,600p from 2,350p.

“After a year of extended conversations with managers across the company, we think Diageo’s often criticised corporate culture is finally evolving in the direction long hoped for by the market. This gives us optimism that management is executing more efficiently than at any time in recent memory; we are, in effect, giving the benefit of the doubt to a management team that is affecting change in a meaningful and constructive way,” it said.

HSBC explained that it kept its rating on the stock at ‘hold’ during the post-Brexit rally as it reckoned the shares were being boosted by Brexit currency tailwinds rather than fundamentals, and it would need to see more from the group before giving it the benefit of the doubt.

“But what we have now is significantly more confidence in Diageo as a commercial organisation with a stronger strategic backbone than at any time in the past.”

The bank said it was upgrading the stock for two reasons.

Firstly, it argued that operationally, Diageo is focused on meaningful cost control, benefiting from a booming and well-resourced Reserve portfolio push and stoking solid local growth stories.

“All of these we believe will continue to drive the stock from here post the Brexit vote rally.”

Secondly, it pointed out that thanks to the company’s high operational exposure to the US and the eurozone, the recent update to HSBC’s global cost of equity estimates has an immediate positive impact on its discounted cash flow valuation.

“Trading at a price-to-earnings ratio of 21.1x versus our calendar 2017e earnings per share of 103.62p, the stock remains at a 5% discount to the group average of 22.5x, making it an attractive option versus expensive peers.”

Metro Bank posted its first ever quarterly profit on Wednesday, but that didn’t stop RBC Capital Markets from cutting its view on the stock to ‘sector perform’ from ‘outperform’ as it pointed to a strong price performance.

RBC noted Metro is now trading at around its price target of 2,700p and has materially outperformed the market.

“We still like Metro, its Q3 results and growth profile, and against an uncertain economic outlook, we reaffirm our confidence that our forecasts remain achievable.

"However, following Metro’s robust share price performance, we believe the fact that the share price approximates our target price, when coupled with the potential downside risk given upcoming Brexit negotiations and economic uncertainty, justifies our downgrade to sector perform.”

Metro said on Wednesday that it swung to an underlying pre-tax profit of £0.6m compared a £3.4m loss in the same quarter last year, as revenue surged 78% to £53.4m.

RBC pointed out that Metro is deposit funded (at below peer rates), maintains conservative ratios and is taking market share, growing at impressive levels, and engages in low risk lending.

“Further, management is best-in-class and Metro’s brand and reputation for exceptional service continue to develop. We remain confident that our forecast of over 250p in earnings per share in 2020 is achievable.”