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Thursday, 18th April 2024 |
| Tips for 2004 - FINANCE 'Analysts of the Year' 2003 put forward their stock recommendations for 2004. |
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| The winners in the 2003 FINANCE Stockbroking Survey ‘Best Analyst Categories’ give an overview of what the coming year may hold for the companies in the sectors they cover, and which companies are the ones to watch into 2004. |
Building Materials
Robert Eason, Equity Analyst, Goodbody Stockbrokers.
On both sides of the Atlantic construction markets over the last couple of years have experienced a significant slowdown and this has translated into declines in earnings for a lot of European building materials companies. Following a period of heavy investment, this fall in earnings has meant many companies are facing highly geared balance sheets. As a result, in any cyclical upturn, the immediate focus for a number of companies will be reducing debt levels rather than expanding their operations though capital expenditure or acquisitions. In contrast, all the Irish building materials companies have strong balance sheets which leave them well positioned to complement the benefits of any cyclical upturn in economic activity with acquisitive growth, thereby allowing them to outperform their international peers. We particularly highlight the following three companies CRH, Grafton and Kingspan.
Over the years CRH has clearly demonstrated its ability to create value for shareholders by using its balance sheet to acquire businesses. This is reflected in CRH’s track record of growing earnings by over 25p.c. per annum over the last ten years, which compares to less than 15p.c. for its international peers. Following CRH’s largest acquisition in 2003, (Cementbouw in the Netherlands for €693m), the company is well on target for a record c.€1.6bn level of spending. Such is the company’s balance sheet strength (gearing of c.45p.c.), we believe it has the financial flexibility to continue undertaking such a level of deal flow thereby ensuring a return to double-digit earnings growth. Therefore, from a long-term perspective we believe the current weakness in CRH’s share price provides investors with an excellent opportunity to buy into a quality global company. However, the share price in the short-term is likely to be volatile given the sensitivity of earnings to dollar weakness.
With earnings in the building materials sector coming under pressure over the last two years, Grafton’s quality has come to the fore as it has continued to produce solid double-digit earnings growth. We are forecasting this momentum to be maintained in the medium term on the back of structural growth stories of Irish DIY and UK dry mortar and its successful acquisition strategy, especially in the UK builders merchanting market, which continues to consolidate. Indeed, despite a record level of acquisition spend in the current year (c.€200m), Grafton still has the financial flexibility to undertake acquisition spend of at least E90m per annum over the next five years, which we believe has the potential to add over 25p.c. to earnings.
With 70p.c. of Kingspan’s business targeted towards the non-residential construction sector, it has been affected the most by the cyclical downtrun. This is reflected in an 18p.c. decline in its operating profit from peak levels reached in 2001. However, we believe the company is set to return to growth in 2004 on the back of continued momentum in its regulated-driven operations (mainly insulation related products) and the benefits of cost reductions in those business areas which have been most affected by the current cyclical downturn (mainly raised access floors). Despite the depressed earnings, Kingspan’s balance sheet (gearing of less than 45p.c.) leaves it plenty of scope to grow the business organically and at the same time progressively increase its dividend.
Airlines
Joe Gill, head of institutional equity research at Goodbody.
Ruthlessly competitive, tremendously dynamic and undergoing revolutionary change - that characterises the airline industry in the western world which is a large business by any measure.
Together, the US and Europe sit under skies that carry over one billion passengers every year. The airline industry that handles that traffic is still evolving from a post World War 2 regulated and largely State-owned industry to one where private sector forces are being fully applied. In that maelstorm, the ownership of the industry is also undergoing radical change. While the bulk of passengers continue to fly on aircraft owned by incumbent flag carriers (many still fully or partially owned by their respective governments), the growth momentum is with privately-owned low-cost airline business models that are cutting swathes of market shares away from the incumbents.
This pattern originated in the US with Southwest during the 1970s but is now underway in Europe (led by Ryanair and easyJet), Australasia (Virgin Blue and Air Asia) and Latin America (GoL). There are simple common denominators across all these geographies: (i) similar business models that focus on simplified low-fare structures with a common aircraft type fleet (ii) consistent profitability, even in the adversity caused by 9/11 and subsequent global conflict (iii) volume momentum that is taking the low-cost carriers’ market share to above 20 per cent in most markets, with all observers agreed that the LCC (Low-cost Carrier) share should grow to over 40 per cent by the end of the decade.
In 2004 we expect evidence of these trends to continue unfolding. While the well-structured low-cost airlines continue to prosper and increase their scale, more traditional carriers will fade, merge or collapse. We think those most at risk include airlines that previously focussed on charter-type holiday packages and those flag carriers that remain heavily indebted and have been unable to radically lower their unit costs. In Europe we judge Alitalia, SAS and Swiss among the latter, with MyTravel, Thomas Cook and HLX in the former category.
For the growing low-cost airlines, 2004 should display evidence of another year of 20 per cent+ volume growth and even faster profit momentum. Further aircraft deliveries in the next five years will fuel continued growth of the low-cost airlines, and we expect their combined passenger volumes to exceed 85m by 2010. A resolution to the EU Commission Inquiry at Charleroi airport will also clarify the route Ryanair will take to expand its business model over the medium-term. If the ruling is adverse we expect Ryanair’s growth to primarily take place via privately-owned airports. If that ruling is neutral to positive the growth will be across all European markets.
To date the growth by both of the largest European LCCs has been concentrated on cross border routes within Europe. We now expect that a greater emphasis will develop on the intra-country routes that have remained the privilege of the incumbent flag carriers. In particular we see the Rome-Milan, Madrid-Barcelona and north-south German corridors will gain attention from the LCCs. These routes tend to be dense and lucrative. Equipped with their industry-beating low unit costs the LCCs can attack these markets profitably although a robust and highly politicised reaction from the flag carriers can be anticipated.
Media
Neil Clifford is an equity analyst at Goodbody Stockbrokers.
The European media sector dropped to a 10 year low in March of 2003, but has recovered strongly over the last 8 months, up 31 per cent compared to a 23 per cent recovery in the broader market. While recovering sentiment towards media stocks following the war in Iraq has been the key driver behind this performance, we believe that valuation multiples are now at level where earnings upgrades will be needed if the sector is to advance significantly ahead over the course of the next year. A key driver of earnings upgrades will be a substantial improvement in advertising.
In relation to the two Irish quoted media companies, Independent News and Media (IN&M) and Ulster Television (UTV), it should be noted that the two are very different companies in terms of their media and geographic focus and we expect different dynamics to drive their individual performance during 2004.
IN&M’s share price has strongly outperformed its sector during the latter part of 2003 following its recapitalisation and improving advertising market conditions in its southern hemisphere operations.
The two potential drivers of upside to IN&M’s share price during 2004, in our view, will be a recovery in newspaper advertising in its core Irish market and a continuation of recent positive currency trends. The Irish newspaper advertising market turned marginally positive in the second quarter of 2003 and the potential for stronger growth during 2004 has improved in line with more positive economic indicators, most notably Irish consumer confidence which showed its biggest increase in 12 months in October. On the currency front, the rand, the New Zealand dollar and the Australian dollar have all continued to strengthen against the euro in recent months and earnings upgrades during FY04 will follow if current exchange rates are maintained into the New Year.
UTV’s share price also forged ahead of the sector towards the latter part of 2003 as the market began to apply much more significant valuation multiples to UK broadcasting stocks in anticipation of a strong advertising recovery. Growing expectations that the smaller ITV licensees will be eventually acquired following the approval of the Carlton/Granada merger added further fuel to its share price performance more recently. Looking ahead to 2004, the two potential upside drivers for its share price are likely to be a recovery in ITV ratings following the completion of the Carlton/Granada merger (ITV plc) and the realisation of better returns from its radio operations in the Republic of Ireland. ITV plc will be a much more focused company and UTV will benefit from its clear intent to reverse the decline in ITV ratings that has taken place over the last number of years.
In relation to UTV’s radio operations, clearer signs that its network strategy is beginning to pay off will give the market greater confidence about the strategy’s potential for creating future shareholder value.
Food
John O’Reilly is an equity analyst at Davy Stockbrokers.
The nutrition and diet paradigm of post WW11 period is under close scrutiny as developed societies wrestle with the consequences of diet (at least in part) related illness. Atkins gives very public expression to this paradigm shift. Atkins of itself may prove faddish but the context of which it is part will persist. In a sense we may be entering what could be described as a postmodern food era, one which curiously has a decided retro feel to it.
For an increasing number of consumers food is confusing; there is a growing equivalence of highly processed and cheap food with illness (recognition of which has expanded the organic food market, seen Europeans baulk at GM foods and created the increasingly Slow Food phenomenon). Modern medicine is similarly viewed, one effect of which is the tendency for self-management of health and a proverbial flocking (at least in the US) of people to alternative medicine. Food and medicine are becoming more symbiotic— the former viewed as a means of avoiding the symptoms the latter proposes to cure. Hence the current nutraceutical, functional food and beverage rage. How all of this spins out is unknown. But it seems inescapable to conclude that the outcome will over time have a significant negative on strategies which are locked into the existing paradigm.
The comfort for companies is that it will be a progressive, not a radical process, one which will afford time in which to adapt (though waiting for the crowd is hardly the basis for a competitive edge). The everyday threats of everyday low pricing, currency change or raw material price increases, or competitor pricing pressure, pale in comparison to the strategic threat posed by a revolutionary shift in attitude to diet and nutrition and the unwillingness or inability of food companies to recognise and anticipate the effect of this.
As noted, as things stand the Irish listed food companies are in good shape, for the most part running their businesses optimally. Strategies are embracing a changing environment. The sector with a near 20 per cent share price gain ytd (as this is written) is fractionally ahead of the overall market performance. It is losing some momentum as the prospects of improving economies push more cyclical sectors forward. If such anticipation proves pollyannish then expect foods to outperform next year.
Technology
Gerry Hennigan is an equity analyst at Goodbody Stockbrokers.
In terms of the technology sector performance, 2003 proved to be a mirror image of 2002, as demonstrated by the steady rise in the Nasdaq since March of 2003, following a similar move in the opposite direction the previous year. Year-to-date the Nasdaq is ahead 46 per cent compared to 20 per cent for the S&P and 17 per cent for the Dow. Underpinning sentiment were initial signs of stability in the demand outlook followed by a steady improvement in the results emanating from the sector as the year unfolded. The question however is, whether recent gains can be maintained and, more importantly, sustained into 2004 in the face of valuation concerns that some suggest will limit any further upside.
Several factors are ‘key’ to driving share prices across the sector in 2004, in our view. Principle among these is continued momentum in the earnings recovery of Q2 and Q3, amid signs of solid economic fundamentals to tempt the corporate sector to re-invest in technology. Evidence to date, suggests that will be attained in Q4, with the seasonally weak Q1 providing a sterner test particularly for those companies with exposure to weak vertical market segments such as telecommunications.
The underlying fundamentals still point to an upward trend however, and we anticipate job gains rather than losses in 2004, an increase in corporate spending and an improved earnings outlook as we face into the early part of the year.
Such an environment will also help the smaller companies in the technology sector that, in our view, have suffered disproportionately during the downturn, in part, due to a flight to safety, but also due to smaller entrenched customer bases and less mature markets. On balance, however, despite valuation concerns, the outlook for the sector as a whole in 2004 is a lot stronger than it was heading into 2003.
From the perspective of the indigenous technology sector issues that warrant attention in the year ahead include; (i) the ability to scale following a period of significant retrenchment; (ii) the leverage inherent in the model and the subsequent potential to drive earnings in a more benign trading environment; (iii) geographic and vertical exposure and; (iv) the currency implications of a weak dollar. The latter is relevant given that most report in dollars but have a cost base weighted towards the euro. The overriding aim will be a successful transition towards profitability, thus negating any of the concerns outlined above. On balance, we expect, and already have seen, a marked increase in valuations over the second half of the year for indigenous tech companies largely for the reasons that pertain to the sector as a whole.
Mid-cap
John Sheehan is an equity analyst at NCB Stockbrokers.
Midcap exposure in the Irish market proved profitable for investors in 2003, with stocks significantly outperforming most of their larger peers. This trend was not confined to the Irish market, with the European and US small and midcap sectors outperforming the larger index by 15 per cent and 18 per cent respectively to date in 2003. This followed a prolonged period of underperformance by the sector globally up to 2000, since when impressive gains have been made.
The outperformance we saw in 2003 can be attributed to several factors. Firstly, the midcap sector has continued to deliver strong earnings growth. Niche positions in growth markets and proven acquisition and development formulae have enabled impressive progress to be maintained, even in slower economic times. Irish midcap industrials, which have delivered impressive earnings growth over a protracted period, include DCC, Grafton, Heiton, IAWS, Irish Continental and Kingspan. Other sectors have similarly produced strong performers.
The second contributor to price performance has been the upward rating of many of these stocks from what were low valuations, not reflective of either past or prospective growth. A continued broadening of shareholder bases has also been a positive for valuations. Irish companies have long recognised the importance of this function and have devoted both time and resources to it. As a result, many Irish midcaps have impressively diversified shareholder registers, the envy of many of their peers internationally.
Following the strong performance in 2003 the obvious question is ‘where next for these stocks’.
We expect further gains in 2004, based on positive earnings momentum in the sector. This is likely to prove the major catalyst for stock price performance, rather than a further upward rating. Proven management teams remain in place, business models are robust and a more favorable global economic wind should be a positive. It is notable that, although Ireland served as an important base for most of these groups, many have successfully diversified their earnings bases in the UK, US and Continental European markets. Ireland accounts for less than half, significantly in some cases, of the earnings base of most of the companies above. This should position them to benefit from a broader international upturn.
The growth in market capitalisation of many of these players has also elevated them onto the ‘radar screens’ of an expanding range of investors, with resulting improvements in liquidity. A recent study by NCB indicated that, Europe-wide, stock turnover as a percentage of market capitalisation is relatively consistent through the Eurotop 600 index, implying that smaller companies are not at a disadvantage when liquidity is judged on a relative basis. We therefore continue to recommend a full weighting of the leading Irish midcaps entering 2004.
Pharma & Healthcare
Dr Ian Hunter is pharmaceutical and healthcare equity analyst at Goodbody Stockbrokers.
The pharmaceutical sector has suffered a mixed year to date. Company specific issues such as increasing litigation concerns, the threat of generic erosion to revenue, lack of pipeline progress and poor operating conditions continued to hold back the sector. These require to be addressed on a company-by-company basis through 2004 for sector conditions to improve. A late fillip did, however, materialize in November with the passing of the US Medicare bill, with its potential to increase spending on drugs in the US by c.$19bn per annum.
In contrast, the biotech sector continued to out-perform general indices throughout the year, driven by high profile mergers and acquisitions (e.g. Biogen and IDEC) and lucrative partnering agreements (e.g. Amgen and Biovitrium). Having also moved ahead in 2003 on drug trial success and new drug approvals, pipeline progress has to be maintained through 2004. Not only publicly quoted companies but also private companies have been attracting cash through 2003, raising the possibility of IPO activity in 2004 providing a further boost to the sector.
The European wholesale sector remained under pressure in 2003 with pan-European companies feeling the brunt of a raft of issues related to cutting the cost of healthcare. In contrast, contract research remained particularly strong, buoyed by a lack of large-company M&A activity, positive M&A of biotech companies and continuing pipeline momentum from both the biotech and traditional pharmaceutical sectors.
Within the Irish context, 2003 was a year of flux. Through acquisition, in-licencing and pipeline approvals, Galen moved from a three-product company to one with a portfolio of nine drugs, focused on both the US women’s healthcare and dermatology markets. The company proved that it can bring a range of new products on board without loss of momentum or margin, while still generating cash of up to $200m per annum. The company is now well placed for further growth in 2004 both organically (expect 25 per cent plus) and through further acquisitions.
Elan has all but completed its recovery programme, raising $1.9bn from business, product and investment sales. This was augmented by a share and convertible issue late in the year (raising $595m), dispelling any mid-term liquidity concerns. Notwithstanding the legal overhang (an SEC ruling is possible in mid-2004), the company can now be considered a fully-fledged biotech company. Elan remains a high risk, news flow-sensitive play, and dependent on the development of Antegren for long-term survival. Through 2004, company progress will hinge on the SEC inquiry, news flow on the product pipeline and evidence of increasing operational efficiency.
United Drug remains a reliable performer with strong earnings growth driving a 37 per cent increase in price year-to-date. Unlike its pan-European peers, United Drug is operating in two robust healthcare markets (Ireland and the UK) with continuing room for expansion. Where mid-teen growth is guided for United Drug, its peers struggle to hit five per cent. With its strong Irish wholesale and drug distribution businesses generating a reliable source of cash, look for extra momentum through 2004 to be delivered from development of its higher-margin medical and scientific and contract sales divisions.
In 2003, Icon firmly established itself as one of the top five contract research companies in the world. This has been reflected in share price, which has appreciated 56 per cent year-to-date. A 1.5m share issue during the year failed to halt the price momentum. We believe, however, that having raised cash in October, the market is currently pricing in an execution premium (e.g. an earnings-enhancing acquisition). Catalysts for the company in 2004 will include the continuing drive from pharmaceutical companies to outsource clinical trials and further acquisitions to broaden the Icon service offering.
Hotel & Leisure
Peter Horgan is hotel & leisure analyst with Goodbody Stockbrokers.
While the Hotel & Leisure sector in Ireland is small (market cap €1.04bn) we believe that it includes two quality companies that have the potential to outperform in the long-term. These are Paddy Power and Jurys Doyle Hotel Group. Both of these companies have very strong Irish franchises and from this strong base are expanding into the UK. We believe that this strategy has the potential to give both of them long-term double-digit growth.
Despite a slowdown in the hotel market over the last two years Jurys continued to implement its strategy of disposing of low margin 3 star hotels and rolling out higher margin Jurys Inns in Ireland and the UK. Jurys Inns have operating margins in the region of 45 per cent - 55 per cent compared to 20 per cent - 30 per cent for traditional 3 star hotels and have returns on invested capital of over 15 per cent. Jurys has opened three inns since the start of 2002 and will open five inns and one hotel in Boston between now and 2005. This strong pipeline of openings will be the main driver behind Jurys return to double-digit earnings growth in 2004. There is further upside potential from its cyclical 4 star estate if the current signs of a return of the corporate and conference traveller materialise into a full recovery. Jurys should benefit in the first half of 2004 from an easy comparative given the depressed levels of travel in the first half of 2003, due to the war in Iraq and SARS.
Paddy Power is the leader of the off-course betting market in Ireland with 30 per cent+ market share. It has achieved this through its unique competitive trading strategy, which leads to lower margins but helps Paddy Power drive a higher turnover per LBO (licensed betting office) than its competitors. Its LBOs are also more profitable. This asset sweating model and its organic growth path means that it drives ROACE of 159.6 per cent versus 18.6 per cent for William Hill, its closest peer. Paddy Power has begun to expand into the UK (it has an internet and telephone offering there since 2001) where we believe that its competitive offering will help it win market share as the market deregulates. It is targeting 12 LBOs by the end of this year, and 30 by the end of 2005.
This process is slow as it has to apply to a local magistrate for each new premises and its competitors can object on the grounds that all betting demand is satisfied in the area. The UK DCMS (Department of Culture, Media and Sport) released the Draft Gambling Bill on the 19th of November, which will deregulate the market and make it easier to open new LBOs in the UK. This should make it quicker, easier and cheaper for Paddy Power to expand its estate but is unlikely to happen before 2005. We believe that Paddy Power can achieve strong long-term growth in its UK LBO business and thus continue to generate double-digit earnings growth well past the current 3-year forecast period. |
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| Article appeared in the December 2003 issue.
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