Broker tips: Shell, Greggs, AB Dynamics, BAE
Uncertainty surrounds the outlook and investment case for Royal Dutch Shell after the company cut its dividend, Berenberg analysts said as they reduced their rating on Shell shares to 'hold'.
Shell cut its first-quarter dividend by two-thirds to 16 cents a share on Thursday to conserve cash after the Covid-19 crisis hammered oil demand and prices. The cut was the first by Shell since the second world war.
Berenberg said Shell would benefit from any recovery in oil prices and the wider economy and the dividend cut will support its balance sheet but the future is uncertain. The broker cut its rating on Shell shares to 'hold' from 'buy' though it increased its price target to €16.70 from €16.30.
"The strategy beyond the immediate crisis appears unclear at this point, however, as does the path to higher cash flow or shareholder returns, and the broader capital allocation framework as the situation normalises," Berenberg analyst Henry Tarr wrote in a note to clients.
Tarr said he expected a mix of dividend growth and buybacks when Shells gearing is reduced and that the company had more scope to increase investment in low carbon technologies. As the balance sheet improves Shell may also turn to acquisitions to accelerate its progress.
But the outlook for the second quarter highlights business disruption. Production is expected to fall by 26% due to Opec+ cuts and shut-ins linked to infrastructure constraints or the economy, Berenberg said.
Shore Capital downgraded its stance on shares of bakery chain Greggs to ‘sell’ from ‘hold’ on Friday as it pointed to "post-lockdown strains to come" and the potential for earnings per share and valuation pressure.
"The coronavirus crisis is a disaster for Greggs," ShoreCap said, noting that 2020 will see an earnings and dividend wipeout.
"We would expect rebuilding in the years thereafter but with a somewhat depleted balance sheet," it added.
The broker said it will take "some years" to rebuild to FY2019 earnings per share as new norms impact Greggs' earnings from a sales and cost perspective.
"Indeed, social distancing and behavioural change, less commuting and a decline in employment, could represent a perfect storm for Greggs," said analysts Clive Black and Darren Shirley.
"Whilst an adaptable and very well-operated business, strong management and a leading value proposition are all virtues, we feel that 19.6x peak earnings (FY2019) represents an unfavourable risk-reward equation given that medium-term earnings could be materially lower than pre-coronavirus levels.
"As such, Greggs could be structurally de-rated on a lower earnings base."
Analysts Berenberg initiated coverage on AB Dynamics at 'buy', telling clients the recent sharp drop in the shares provided a "compelling entry point" given the strong balance sheet and valuation discount versus peers.
"With the shares down by c40% in the past six months, there is now a compelling entry point into a multi-year compounder. We initiate coverage with a Buy rating and a 2,050p price target."
The global leader in automotive testing systems had generated a compound annual rate of organic growth of 14% over its 2020-22 financial years with operating margins and a return on invested capital of 23.3% and 25%, respectively, in FY 2021.
It also had £35bn of net cash on hand and enjoyed strong pricing power, barriers to entry and a strong brand.
Furthermore, the long-term structural growth story remained in place, with significant opportunities in the autonomous vehicle space.
"We believe consensus is underestimating the medium-term margin-progression story and our FY 2022 EBIT margins are 70bp ahead."
Deutsche Bank stuck to its 'buy' recommendation on shares of BAE Systems', telling clients that while profits would drop sharply in 2020, a recovery would follow in 2021 and the engineer would make good on its dividend payments - or mostly.
"While Defence companies surely have a greater chance than most of a quick recovery to pre-crisis levels of activity, a lot will depend on the state of governmental budgets and any reprioritisation that might be required, in our view," the broker said.
The Covid-19 pandemic is expected to hamper its workers and disrupt supply chains throughout most of 2020, although those headwinds are expected to ease from the third quarter onwards.
At some of its business units, sales were seen crashing by as much as two thirds in the second quarter and by up to a third in the third quarter, before "some material 'catching up' from 4Q onwards".
As a result, the firm's earnings per share were seen falling by 14.1% against 2019 to reach 39.4p but expected to recover by 21% to 47.5p in 2021.
The approximately £300m hit to profits is expected to flow through to BAE's cash-flow which is now pegged to be at £750m in 2020, although there are some upside risks.
Deutsche also incorporated the company's new deficit recovery plan into its estimates, which it said would add £1.45bn to free cash flow in 2022.
Regarding the company's dividend policy, the analysts assumed that the final payout for 2019 would be paid, albeit not until the back half of 2020, and that no interim dividend would be paid for 2020, although a full final dividend for the year would be forthcoming.