Broker tips: BAE Systems, Associated British Foods, Tesco

Shares of aerospace engineer BAE Systems have run up by 12% relative to the Footsie over the past quarter, but it’s time to sell, say analysts at Westhouse Securities.

Thus, the firm can be expected to benefit from weakness in sterling. However, several negative aspects seen in recent reporting periods have been replaying themselves. Amongst these one might mention: a shipbuilding charge, slightly weak order intake, goodwill impairment and a potential disruption from the ‘continuing resolution’ (CR) in the US Congress.

The latter of those issues may likely endure longer than 2014, the broker says, to which one can add management’s caution.

With only 19 voting days left for the house this year CR may well run into the next, Westhouse explains.

Furthermore, the company’s book-to-bill ratio of 0.75 times the broker’s 2014 revenue estimate is “low”, despite the fact that the average contract duration for the company is longer than for others.

For all of the above reasons Westhouse Securities reiterated its sell recommendation and 469p target.

As emerging market economies continue to slow and the developed world takes centre stage it is hard to find a better structural growth story than Primark, analysts at Credit Suisse explained to clients on Tuesday. For that reason they decided to upgrade their recommendation on the stock to 'outperform'.

In their opinion the 2015/16 year should see a significant increase in earnings per share (EPS) as the number of Primark establishments opening accelerates and the company enters the US. As well, the profitability of the sugar division has reached its trough, they believe, and will likely recover smartly as the lower beet prices feed into earnings.

EPS, they calculate, will expand at a 15% clip.

Hence, the stock’s EPS multiple is now forecast to decrease to 24 times next year in comparison to 30 times this year.

Given that the Swiss broker’s ‘sum-of-the-parts’ valuation is still pointing to a price target of £30 it has decided to upgrade its recommendation on the shares to ‘outperform’ from ‘neutral’, with a 3,000 price target.

As of 16:12 shares in Associated British Foods are advancing 4.53% to 2,679p.

For analysts at Nomura the latest ‘profit warning’ from Tesco puts that company’s credit metrics effectively into ‘junk’ territory, as per a research note issued on 29 September.

As regards the company’s fundamentals, if one takes the better part of the firm’s £250m profit warning at face value then that means its operating margins in the UK, on an EBIT basis, would come in at 2.8%.

The key metric is the company’s gearing they point out and, in turn from the above, they estimate that the retailer’s net debt to operating earnings (adjusted EBITDAR) comes in at 3.65, whereas the threshold for ‘junk’ in the sector comes in at 3.5.

However, while they believe that a rights issue just got “a lot more likely” they still do not believe it should be the “base case” , nor do they believe it would be the right thing for the supermarket operator to do.

Hence, they further point out that on the basis of the company’s debt refinancing schedule, and of the current likely rates – using CDS on existing debt as a proxy for example – suggest the impact of becoming and remaining junk for several years in terms of interest cost would be negligible.

Should the company attempt to recover a position in the middle of the pack in terms of the aforementioned debt multiple that would imply raising about £2bn, or issuing approximately another 15% of shares, “probably at a significant discount”.

The broker maintained its ‘neutral’ recommendation on the shares and 200p target.

As of 15:40 shares of Tesco were down by 1.63% to 185.65p.