Broker tips: Wood Group, Dechra Pharmaceuticals, RBS, United Utilities
Jefferies has downgraded Wood Group, over concerns that the dividend could come under pressure at the energy services firm.
Jefferies, which reset its price target on the shares to 480p against a previous goal of 550p, reduced its rating to ‘underperform’ from ‘hold’. The decision weighed heavily on the stock, and by 1000 GMT on Monday the shares were off nearly 6%.
In a note called 'Deferred Deleverage', Jefferies said: “We see a similar progressive dividend risk with Wood Group to that we saw with the Amec Foster Wheeler deal. Wood Group’s excellent strategic track record in mergers and acquisitions and balance sheet management will be tested to the full.”
Wood Group, which completed its $2.2bn takeover of Amec Foster Wheeler in October 2017, updated the City on Monday about its non-core asset disposal programme, and said it had agreed to sell its Terra Nova Technologies unit to Cementation Americas for $38m.
But Jefferies argued that Aberdeen-based Wood’s ongoing plans to cut debt would be at risk if disposals slipped.
While Wood continues to see $200m to $300m of future disposals, the bank’s analysts said timing "appears less certain" and with known cash exceptions of $100m, "we wonder about the unknowns".
The analysts also pointed to upcoming changes to the way Wood Group will report earnings and revenues, thereby creating “more complex” historical performance comparisons.
The analysts said that with all the changes from the merger, reported earnings "has to be a function of valuation as frankly it is one of the few consistent measures we have" but, after updating for lower exceptional costs but higher interest and tax produces, a 2019 net income forecast of $74m is still materially below the average City profit forecast of $193m for 2019.
Analysts at JPMorgan Cazenove initiated coverage on Dechra Pharmaceuticals at 'overweight' on Monday, calling the veterinary products manufacturer a "diamond in the ruff".
JPM, which sees animal health as an "attractive" healthcare subsector, said the industry was "fragmented" and felt Dechra was Dechra highly capable of creating "significant value" through mergers and acquisitions.
The investment bank's analysts saw attraction in the animal health industry as a result of its strong demographic demand, increasing spend per pet, and increasing animal protein consumption.
Low development costs are another appealing element for the analysts, with the FTSE 250 constituent only needing to reinvest around 5% of revenues, and the sector's "superior sustainability" when compared to human pharmaceuticals, with "far more modest genericisations".
The analysts, which issued Dechra a twelve-month target price of £30, expect to see Dechra's core EPS grow 11% between 2020 and 2023E, driven by a combination of "strong growth in demand for pet medications" and 200bps worth of operating margin expansion.
"We see potential forecast upside from pipeline optionality and M&A. We set a Jun-20 PT of £30, 26x 2021E Core-PE, justified by the strong base business outlook, and upside optionality," concluded JPM.
Jefferies jacked up its target price for shares of RBS following a meeting with the lender's finance chief, Katie Murray, that saw them come away with "more conviction than ever around large scale capital return".
Following their discussion with Murray, the analysts pencilled-in £1.3bn-worth of buybacks and a corresponding reduction in the lender's share count that saw their 2021 based target price rise from 341p to 489p.
That share count reduction accounted for 123p of the bump-up in their target price.
"However unlikely in practice," the analysts said, RBS's finance director had emphasised the ability to purchase an additional 10% of shares on the open market "prospectively meaning that RBS could buy back up to 14.99% of its shares in a year".
On the asset side of the equation, the analysts said it was reasonable to anticipate stable net interest margins even if the hike in Bank Rate that was projected to take place in the third or fourth quarter of 2019 was pushed into the following year.
Each 25 basis point rate hike from the Bank of England was equivalent to £250m of incremental revenues over the subsequent 12 months, they estimated.
"As an asset sensitive bank, RBS’s revenue would be supported by higher base rates and we believe at least two 25bps rate hikes are needed to drive a 2021 C/I meaningfully below 50%," they added.
Jefferies stood by its previous 'buy' recommendation on RBS shares.
Deutsche Bank downgraded its stance on shares of United Utilities to 'hold' from 'buy' as they have risen above its 850p price target.
DB noted that the stock has risen strongly since its upgrade to 'buy' on 1 October 2018, with rising confidence around future incentive scheme performance improvements and moderating concerns around political risk.
"However, the stock now looks less clearly undervalued, having risen above our 850p price target," it said.
"Furthermore we believe that UK political uncertainty is rising again as the Brexit negotiations come to a head with growing downside risks."
Deutsche said the UK water companies continue to offer attractive regulatory earnings yields of around 8-8.5% if we look ahead to after the next regulatory review. However, its assessment of political risk-reward now looks slightly skewed to the downside.
For United Utilities, it sees around 10% further upside if political risks fade away entirely with circa 15% downside if the stock trades back down to RAB.
"The key risks relate to political developments and the company’s ability to perform under incentive schemes after its review."
DB said it now has no UK regulated utilities rated at 'buy'.