Sunday share tips: Redrow, WPP
In his ‘Inside the City’ column for the Sunday Times, Liam Kelly noted an interesting disparity in the way markets treated two housebuilders last week.
On Monday, Berkeley Group chairman Tony Pidgeley cashed in £50m of his shares, sending the share price south by 2.5%.
Two days later, Redrow founder Steve Morgan made a similar move, but as pointed out by Kelly, the FTSE 250 firm’s stock kept moving northwards.
The 67-year-old is no longer running the company, having retired in March, and a number of market watchers had felt his stake of almost 30% was dragging on the share price thanks to its effect on liquidity.
And Morgan was not wanting for buyers, either, with Kelly writing that next to its peers, Redrow’s shares look cheap, adding that even though it was trading at record high prices, it still traded at a discount of around 25% to the sector on both earnings and net asset value.
Redrow closed on Friday at 732p, making for a market value of £2.6bn.
It is the country’s fourth largest housebuilder by volume, erecting more than 6,400 dwellings in the year through June, and turning out pre-tax profits of £406m on sales of £2.1bn in its sixth year of record results on the trot.
The firm had not been immune to the margin-flattening effects of the Help to Buy scheme, but under Morgan’s leadership they had been buoyed by the scrapping of cheaper designs, the building up of a strong land bank, and a focus on its ‘Heritage’ range of family homes.
Those moves came after Steve Morgan returned to lead the company in 2009, after his first attempt at retiring.
During his first attempt to walk away from his baby, Redrow fell into crisis, seeing Morgan force his way back in with the help of hedge fund Toscafund.
After a decade back at the helm, former chief executive John Tutte moved to the chairman’s seat, and since April, the combined stake held by Morgan and his charitable foundation had fallen to 20%.
Tutte had not had an easy ride in the months since taking over, steering the company through concerns around pay and governance, but Kelly wrote that he had largely continued the same trajectory as Morgan, with Redrow’s shares up 46% this year.
StockViews analyst Jamie Fletcher had a bullish price target of 1,250p on the stock, and expected the 20% margins to rise by 1.5 percentage points, which he put down to “unappreciated embedded value in the land bank”.
Some in the Square Mile saw that as too optimistic, with Fletcher’s assumptions relying on moderate house-price and build-cost inflation, there were other factors that “suggest that Redrow is set fair”, Kelly wrote.
He said the “stonking” majority won by Boris Johnson in the House of Commons had sated market hunger for some sort of political certainty, with Tutte indicating he believed a cut in stamp duty could be in the tea leaves.
“Then there is the prospect of buyers rushing into Help to Buy before the scheme is restricted to first-time buyers in April 2021,” Liam Kelly wrote.
“Buy,” was his recommendation.
Over in the Sunday Telegraph, ‘Questor’ opened by suggesting holding on to WPP could be worth it, even though its underperformance could be a test of patience.
The advertising giant was in the midst of a “painful yet necessary” move to new media channels, with its clients now demanding “data-driven” marketing through online channels such as Google and Facebook, as well as a bit of creativity to help their e-commerce strategies pay off.
Those kinds of demands had seen WPP increase its “creative leadership” budget by £15m per year, which would be largely targeted at the US market - the company’s largest - in a bid to help its clients adapt to structural changes prompted by new technology.
WPP was also in the midst of its own structural change, having disposed of 30 non-core investments and associates last year, and recently completing the sale of 60% of its research division Kantar.
The disposals, Questor said, had enabled the behemoth to shift to a simpler organisational structure, allowing it to be more flexible and adaptive in a changing market, but had also raised much-needed capital.
Some of that had been used to pay off its liabilities, with net debt falling 10% in the last year, following three years in which it nearly doubled to £4.5bn.
WPP’s disposals were also being complemented by its approach to cost saving, with those expected to total £275m a year by the end of 2021.
That, Questor wrote, made the £300m restructuring costs expected to be incurred as part of its three-year turnaround seem “highly worthwhile”.
WPP’s adaptiveness would also be helped by its existing, large presence in the marketing technology space, with the company having 6,000 employees in that sector, managing more than £6bn of client spending with Google and Facebook in 2018.
Its competitive advantage was enhanced even further by the fact it had existing relationships of nearly three quarters of Fortune Global 500 companies, and two thirds of FTSE 100 members.
And although there was an overall trend towards a reduction in marketing spending among large corporates, the level of spend as a proportion of revenue was still a full percentage point higher than it was four years ago at 11.2%.
Questor suggested that 3.4% growth in the global economy in 2020, as forecast by the IMF, along with a 4.6% expansion in the GDP of emerging markets, could further bolster worldwide marketing spend, with WPP broadening its exposure to fast-growing economies such as China - already working with seven of the 10 most valuable brands in the People’s Republic.
The outlook was not without risks, however, with political instability in both the US and Hong Kong posing a threat.
Internally, its “all-encompassing” transformation plan could lead to a period of major uncertainty for the firm, which Questor said could have been behind part of its share price falls in recent years.
Following those declines, WPP was now trading on a forecast price-to-earnings ratio of 10.4x, which could undervalue the company after it reported progress across its major markets and sectors in its third quarter, as its revenues on a constant currency basis rose 0.5% following a first half decline.
Questor said that trend would “almost inevitably falter” as its business model continued to evolve, adding that investors would need to have continued patience with the stock that was still yet to fulfil its potential following the column’s initial ‘buy’ recommendation in March 2017.
“But Questor sees persevering with WPP as a logical course for existing investors,” it wrote.
“Its new business model, low valuation and exposure to emerging economies suggest long-term recovery potential.”
Questor’s recommendation was ‘hold’.