Broker tips: South32, easyJet, Next, Bodycote

Shares in South 32 were on the front foot on Wednesday after HSBC upgraded the base metal and coal miner to 'buy' from 'hold' and left its price target unchanged at 185p, following suggestions that it will execute a share buyback programme in the first half.

HSBC believes that the Australian miner is likely to pursue a share buyback rather than distribute excess cash in is special dividend as it has not built up sufficient franking credits Down Under.

South32 told HSBC that the company would not necessarily wait until the end of the financial year to execute potential cash returns, and so the bank believes that the company will likely have $1bn of net cash from the $467m it currently has before end of June given the $200m working capital unwind and payment of dividends from Samancor, its manganese ore joint venture.

HSBC said that it was unsure of the quantum of the probable buyback but expects it to be at least $200m, which is broadly similar to the interim dividend of $192m.

On 27 February, South32 said its top priorities were to gain cash to invest in maintaining the integrity of the business by sustaining capital expenditure and to uphold its credit rating by ensuring the balance sheet remains robust with a net cash balance of $500m held through-the-cycle after dividends at the current 40% pay-out ratio.

The miner added that any excess cash beyond this would compete between a few internal projects, mergers and acquisitions and cash returns to shareholders through either dividends or share buybacks.

The bank said that the downside risks to South32 include weaker-than-expected commodity prices as the dollar stays stronger post-Brexit, the inability to deliver targeted cost savings and potentially value-destructive mergers and acquisitions.

Separately, South 32 is currently concerned over the lack of consultation with South Africa’s Department of Mineral Resources regarding potential changes to the country’s mining charter and it is also working with Australia’s regulator to address competition concerns over the acquisition of Peabody Energy's Metropolitan coal mine for $200m, with the deal expected to close by the end of the 2017 financial year.

easyJet

Budget airline easyJet flew higher on Wednesday as Cantor Fitzgerald upped its stance on the stock to 'buy' from hold' and lifted the price target to 1,200p from 1,150p.

The brokerage noted EasyJet gave a cautious outlook for the year in its recent first-quarter statement and since then, consensus forecasts have been cut and the stock is down.

"We now think that the risks to earnings from capacity growth by rival carriers and weak sterling are fully priced in."

Cantor said demand for leisure travel is holding up well and disruption to operations from air traffic control strikes is muted.

"EZJ’s fundamentals remain sound. In particular, fleet expansion plans are flexible if market conditions deteriorate.

"EZJ’s network footprint and exposure to main airports is impressive (e.g. 800 routes and 130+ airports) and this underpins it business model of targeting higher spending passengers."

In addition, the brokerage said the stock's valuation is not challenging, trading on a calendar 2017 price-to-earnings of 10.7x versus a historic average of 15x.

Cantor highlighted the fact that easyJet could be demoted from the FTSE 100 as part of the latest quarterly review and said this could lead to volatility.

"Usually this is a temporary effect. In any case, from a fundamentals perspective, any weakness would present a good buying opportunity, in our view."

Next

Retailer Next got a boost on Wednesday as Redburn double-upgraded the stock to 'buy' from 'sell', saying the drop in the shares represents a good buying opportunity.

When it downgraded the stock to 'sell' in July 2013, it was worried about peak margins and the diminishing range of opportunities to deploy new capital.

Management were able to push back maturity, first via hitting fashion trends and then expanding lending, Redburn said.

"However, over the last eighteen months progress has stalled and far-reaching questions are now being asked of a business and CEO that have so long been sure-footed. The more than halving of the shares since the fourth quarter of Q4 2015 has created an opportunity."

Redburn said fabulous returns at Next reflect its unusual ability to grow like-for-like gross profit ahead of inflation, develop a highly profitable lending book and invest wisely.

"Great financial management has been facilitated by strong retailing and customer understanding."

It said Next is advantaged by its robust brand and business model. While industry pressures are severe, they will squeeze Next’s many thin margin/highly-geared peers earlier, and more profoundly, opening up opportunities, Redburn said.

Bodycote

FTSE 250 constituent Bodycote was down more than 2% on Wednesday after US investment bank JPMorgan Chase lowered its recommendation to 'neutral' from 'overweight'.

The heating equipment supplier's 12-month target price was also raised from 680p to 770p.

JPM believes Bodycote has gained sufficient ground since it was upgraded in December following the release its final quarter earnings report, which was in line with forecasts.

"The shares are up 31% since early December, we had upgraded the stock based on the market's lowered expectations, reflected in conservative estimates and attractive valuation," the note from JPMorgan said.

"We see this situation having reversed somewhat as we now build significant improvement in our estimates, reducing the upside potential."

Weakness in the oil and gas market and a knock-off in demand combined to send the company's sales down in its earnings report, released on Tuesday. Like-for-like sales to the energy markets were down 27%, Bodycote reported.

Its full year pre- tax profits were higher than in 2015 however, rising from £75m to £91.9m.