| Insights into the stock market from Ireland’s top analysts |
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| Ireland's leading stockbroking analysts, as voted by over 1,000 fund managers in the most recent FINANCE Stockbroking Survey, give an overview of what the coming year may hold for companies in the sectors they cover, and which companies are the ones to watch in 2006. Their forcasts, which were written in early January, indicate that the tremendous growth experienced in the Irish stock market over the past few years, is set to continue. |
Robert Brisbourne, Food and Beverages Analyst, Merrion Stockbrokers | | Robert Brisbourne |
The ‘Food and Beverages’ sector in Ireland covers a very diverse set of companies that include businesses ranging from basic commodities to premium consumer goods. As a result, the factors that will influence the companies in 2006 will be very different.
The top performer in the food and beverages sector in 2005 (to date) has been C&C Group, which has appreciated by over 80 per cent since 1 January. The key driver of the C&C share price has been the success of Magners cider in Britain. We expect a widespread roll out of Magners in Britain in 2006 (currently sales are primarily in London and Scotland) and the successful execution of this will be key for the C&C share price performance in the coming year. We feel that Magners is well placed to build on success in London and Scotland and have a BUY recommendation on the stock.
IAWS and Kerry, both of which have very strong long term performance, have had relatively weak share price performance in 2005. For IAWS this was primarily the result of a very strong performance in late 2004 and a relatively high valuation at the start of the year. We feel that IAWS is now well placed to deliver good shareholder returns in 2006. The Kerry share price was held back in 2005 because the growth rate of the group has slowed (consensus forecasts are now for approximately 7 per cent EPS growth in 2005). In order to drive strong shareholder returns in 2006 some indication of a recovery in growth at Kerry back towards historical double-digit rates is likely to be required; visibility on this issue is currently low. Glanbia will also be seeking an improvement in growth in 2006 (after a tough year in 2005).
Elsewhere, EU trade reform is a key theme for both Fyffes and Greencore. For Fyffes the move of the EU banana regime from a quota to a primarily tariff based system is likely to have a large negative impact on profits. This has been in part reflected in Fyffes’ recent share price decline but the ultimate impact of the new banana regime on profits remains unclear. For Greencore visibility on the impact of the sugar regime reform is also low. As Greencore is now widely expected to exit sugar processing the key questions are how much compensation it will receive and how much profit can be made from sugar between now and the time of exit. Greencore’s convenience division had a strong performance this year, maintaining growth and margins will also be key to performance in 2006.
Taking all these factors into account our preferred food and beverage stocks going into 2006 are C&C Group and IAWS.
Neil Clifford, Telecoms/ Media analyst, Goodbody Stockbrokers | | Neil Clifford |
The share price performance of the two Irish telecoms stocks, eircom and Smart Telecom, diverged significantly through 2005 in a year of generally weak sentiment towards the European telecom stocks as a whole, with the former increasing its share price by circa 23 per cent during 2005 against a 21 per cent decline in the share price of the latter during the same period. Looking ahead, we expect broadband roll-out and creating value from investment in mobile are the two themes that will dominate the share price performance of both stocks.
In relation to eircom, the acquisition of Meteor has transformed its investment case and is likely to become the most important driver of its share price over the next 12 months. eircom is aiming to grow Meteor’s share of the Irish mobile market form 12 per cent to 20 per cent over the next 2-3 years and the market will be closely monitoring its progress as we proceed through the year. Achieving growth from broadband to offset decline in its traditional businesses will also be an important driver of its share price performance, in our view. Although the share price has fallen back since Swisscom’s attempted take-over was aborted, the investment case for eircom remains one of the most attractive in the European telecoms sector. The company has a strong fixed line business that isn’t exposed to the same regulatory and competitive pressures as its European peers and owns a fast growing mobile business that operates in one of the most attractive mobile markets in Europe. These factors should at least enable it to develop a premium rating relative to the sector while any upside surprise in the performance of Meteor will boost returns further.
Smart Telecom’s share price performance during 2006 is likely to be closely correlated to the progress the company can make in rolling out its unbundled broadband service. It has, without doubt, a compelling broadband strategy but execution is dependent on the elimination of several regulatory issues, some of which may not be properly tackled until 2007 at the earliest. Better than expected progress on this front is likely to propel its share price forward but the challenges for now remain significant. Securing the fourth 3G licence has been a major success and gives the company a new opportunity for growth but it will be 2 to 3 years before its real potential is known. Given such uncertainties, Smart Telecom remains a higher risk play on the future evolution of the Irish telecommunications market.
During 2005, the two Irish media stocks, Independent News and Media and Ulster Television both underperformed the European media sector, each for its own reasons. In relation to Independent News and Media, the relatively modest increase in its share price during 2005 is most likely a case of ‘pausing for breath’ following a strong outperformance of the sector over the last three years – since the beginning of 2003 INWS has delivered a total return of 114 per cent versus 57 per cent the European media sector. In the case of UTV, a deterioration of the UK advertising market coupled with fact that it has at the same time chosen to increase its exposure to that market via its acquisition of The Wireless Group has possibly been the principal reason behind the decline in its share price during 2005. Looking ahead, while the prospects for an European advertising market recovery look limited for now, the outlook for the two Irish media stocks, Independent News and Media and Ulster Television, looks somewhat more encouraging, driven by a number of company and market specific factors.
IN&M’s limited dependency on any one single advertising cycle, coupled with the potential for further cost efficiencies across all of its operations, underpin its ability to offer investors the prospect of double digit earnings growth over the medium term. Returns on capital employed are continuing to improve following a decline to unsustainably low levels three years ago. While most of the below the line improvements are now complete (i.e. asset/financial restructuring), good scope exists for further improvements via above the line enhancements (i.e. revenue growth and operating margin improvements). We are forecasting that the full year dividend yield will be stepped up by 18 per cent during the current year, leaving the shares on one of the most attractive dividend yields in the sector. While we see limited scope for IN&M’s valuation ratings to expand further given that existing ratings are broadly in line with the sector, the share price should at least grow in line with earnings over the medium term.
Since the beginning of 2006, UTV’s share price already looks like it is well on its way to recovery. The trading statement released by the company in December showed that, despite a weak market backdrop, its UK radio business is performing better than the rest of the market, and radio advertising revenue for its group of UK radio stations is likely to be up by 5 per cent during the second half of 2005. While its television business is continuing to suffer some impact from weaker network advertising (revenues are expected to be down by 3.5 per cent during the second half), this is being offset by very strong advertising growth in its Irish radio business. In our view, the company’s resilient local marketplace (Northern Ireland) coupled with its relatively high exposure to the fast growing Irish economy should continue to ensure that the company delivers robust earnings performances even if weakness in the UK economy persists.
Barry Dixon, European leisure analyst, Davy Stockbrokers
Restructuring assets is likely to be the main themes in 2006, a continuation of the process which has been underway for the past two years. There are still some companies operating the asset ownership model which provides an opportunity for investors in terms of capital return. These include De Vere Group, Whitbread and Hilton. De Vere and Whitbread are also exposed to the growing budget hotel sector a trend we believe will continue in 2006. Finally, the overall performance of the sector should be underpinned by continuing recovery in the industry. Our top picks in the sector for 2006 are De Vere Group and Whitbread.
Hotels were one of the best performing property asset classes in the UK in 2004 following three years of weakness. Anecdotal evidence suggests that hotel asset prices rose again in 2005. During the past year, companies such as Whitbread (with its Marriott chain in the UK), Hilton Group and Intercontinental have all sold assets taking advantage of the property boom. Jurys Doyle Group was taken private largely due to the hidden asset value in its Dublin properties. The disposal of hotel assets by operators is likely to continue in 2006 driven by a number of factors including:
• Continuing growth in property asset values
• The potential introduction of PIF (property investment fund) legislation in the UK.
• Continued pressure on hotel management teams to generate higher returns.
De Vere Group and Hilton Group are most likely to dispose of assets. This could happen at the instigation of management in an attempt to restructure lowly-geared balance sheets and would likely result in a capital return to shareholders. Alternatively, these companies could attract suitors who recognize the free cashflow yields and/ or break-up value. In both cases, 10-15 per cent upside is likely from current levels.
Based on our estimates of property values as well as multiples of cashflow FCF defined as EBITDA minus maintenance capex minus tax divided by current enterprise value (EV).
The economy/budget hotel sector has grown rapidly in the US over the past 20 years. It now accounts for over 44 per cent of total roomstock. The UK market, we believe is on a similar growth trend although is significantly behind the US with only 31 per cent of total roomstock classified as economy/ budget. We believe therefore that this segment of the UK hotel market has significant growth potential.
The main beneficiaries of this growth will be the current incumbents. Whitbread is the largest budget hotel operator in the UK with over 50 per cent market share (in terms of roomstock) with its Premier Travel Inn brand.
We expect the recovery in the hotel sector to continue in 2006. We base this on previous cycles in which the
US market tended to lead the recovery in the rest of the world. Revpar in the US increased by almost 8 per cent in the first ten months of 2005. The London market which most closely follows the US rose by just over 1 per cent in the same period having been negatively impacted by the July bombings and a slowdown in consumer spending which impacted leisure spend in hotels.
Robert Eason, Construction & Building Materials Equity Analyst, Goodbody Stockbrokers | | Mr Robert Eason |
Against a positive backdrop for European stock markets in general (FTSEurofirst 300 up c.23 per cent), the construction sector had another strong year with the main construction index up 33 per cent, which represents the fifth consecutive year of outperformance. While a return to strong double-digit growth was the driving force behind the 2004 outperformance, corporate activity / consolidation has been very much to the fore in 2005 with a number of high profile deals. These have included Aggregate Industries, Heidelbergcement and BPB, which follow on from the RMC deal in 2004.
There is no doubt that consolidation will remain a theme for 2006 with balance sheets in reasonable shape (average Net debt to EBITDA of 1.6x.), thereby underpinning sector valuations, which are near record levels relative to the underlying market. However, the key risks for 2006 are whether the US housing market is peaking, continued cost pressures (especially energy) and will rising interest rates adversely affect what are still fragile European construction markets.
Despite these potential headwinds and strong performances from the Irish building materials stocks in 2005 (especially from Kingspan which is up over 50 per cent versus +24 per cent for CRH and +11 per cent for Grafton), the investment cases remain strong. In particular, we highlight Grafton, which underperformed in 2005 due to negative sentiment towards the UK merchanting /DIY sector that arose from a slowdown in the market. However, unlike its peers, this slowdown did not put Grafton’s forecasts under pressure. This reflected the company’s exposure to Ireland (c.50 per cent of group profits) and the Heiton acquisition performing ahead of expectations. With Ireland likely to remain one of the strongest European economies in 2006 and the prospect of a more stable UK merchanting market (underpinned by further interest rate cuts and improving trends in both housing transactions and mortgage approvals), Grafton is well positioned to outperform in 2006
In terms of the other two main Irish building materials stocks, the diversification in CRH’s operations coupled with its strong balance sheet sets the company up well for another strong year, while Kingspan will continue to take on the mantle of being a growth stock. The latter reflects Kingspan’s positioning in terms of taking advantage of structural trends that are occuring in the construction industry, namely ever stringent building / environmental regulations (underpins its insulation businesses) and a move to more modern methods of construction.
Joe Gill, Airlines equity analyst, Goodbody’s Stockbrokers | | Joe Gill |
The most notable pattern in the airline sector during 2005 was an unusual correlation between rising fuel prices and steady to rising profitability. Despite jet fuel prices increasing by over 40 per cent airlines have been able to pass on a significant amount of this cost pressure via higher fares. That has been led by Flag Carriers. In turn, the low-cost carriers like easyJet and Ryanair have seen their yields improve as passengers opt for their absolute lower prices. A further stimulating factor has been the return of genuine demand for air travel. After the hiatus caused by 9/11 and the War in Iraq passengers are returning in droves. It is estimated overall volume growth in traffic was at least 5 per cent during 2005 and that too helped the economics of many carriers.
Turning into 2006 airline managers are closely watching jet fuel prices. With oil the single largest cost item at present, airlines would like to see some stability for ‘06. Flat or falling prices would provide a benign backdrop for the summer of 2006. It is during these months that seasonal demand helps maximise profits within airlines. If underlying passenger demand continues to grow, and fuel prices stabilise, fares should also be steady next year. That will allow profits grow relatively strongly, especially among the low-cost airlines. And the demons?
A sharp lift in fuel costs would clearly be a major threat. Consumers can only take so many fuel surcharges before absolute demand falters. Also, higher oil could feed into weaker overall economic activity. That in turn could also threaten consumer spending. We have seen some of that in the UK during 2005 but it has not fed into air traffic volumes. Another scary story is Avian Flu. If that were to trip into a major pandemic and force restrictions on people movements anywhere in Europe it would adversely affect airlines. All this highlights the inherent volatility in the airline industry. Never a dull moment.
Jack Gorman, Pharma & Biotech analyst, Davy Stockbrokers
2005 was a good year for investors in global healthcare. Though they can carry plenty of product and pipeline risk, most segments in the US and Europe outperformed their respective markets and continue to have superior growth outlooks for this year and beyond.
For 2006, key themes in the global healthcare sector will continue to be R&D productivity, pricing pressures, restructuring and innovation. Though big pharma looks cheap the segment still has most to lose. Service sectors (with associated plays on outsourcing) and true innovation (biotech) should continue to be winners.
Irish healthcare stocks are operating in sectors that are outperforming and displaying superior forecast growth, underpinning our positive view on prospects for 2006.
Though Elan is for now a Tysabri-specific story, the pipeline opportunity in Alzheimers Disease (AD) may become more tangible as we progress through 2006. Elan will this year look for signals that are strong enough to propel two products into their next phases of clinical development.
Elsewhere, the granting of priority review status in November-2005 underpins the fact that the FDA still considers Tysabri to be a very important MS drug – a re-launch in the US market could occur by Q2 2006.
Notwithstanding the year end surge in the stock, there remains considerable potential upside supplied by strong commercial momentum on Tysabri and by progress in the AD programme.
We acknowledge that the Irish drug pricing review continues to influence the United Drug story. A price reduction similar to the UK review would knock only a couple of points off one year’s growth and looks to be worst case as the review’s emphasis may lie on generic penetration rather than price reductions. Our forecasts anticipate EPS growth of 12 per centand 10 per centin each of the next two years, which we believe is conservative for one of the best growth stories in the market.
ICON stands out as an undervalued CRO with improving growth prospects. Earnings visibility is improving and strong business wins in the labs division are providing a platform for a return to profitability. Earnings upgrades are possible as we go through 2006 and can help close the 20 per centratings discount.
Across Irish smaller cap healthcare, Trinity Biotech is on track to deliver on 2005 forecasts after solid Q3 numbers. Relative to small cap diagnostic peers the company is inexpensive in PE and price/book terms.
We initiated coverage of Amarin in September 2005 – this is a drug development play focussing on niche segments of the CNS market. 2006 is a very important year for the company and a steady stream of licencing and pipeline-related newsflow should be generated. The stock holds the potential for substantial upside from current levels, based on prospects for its lead product Miraxion.
Last but not least, Alltracel is delivering operationally across its woundcare, oral care and cholesterol research applications. Several exciting business development initiatives announced during 2005 should begin to bear fruit during the current year. This should drive a share price recovery from depressed current levels
Eamonn Hughes, Financials analyst, Goodbody Stockbrokers
We like the Irish story going into the New Year, which is underpinned by the cyclical upswing in prospect from the SSIA releases in 2006 and 2007. While there will be incremental funding costs for the bank sector as the SSIA funds roll-off, we anticipate this will be more than offset by fee income from the higher levels of activity likely in the economy, where the bank sector is obviously well positioned.
The Irish banks had a strong H105 share price performance, but gave up well over half of their relative gains against European banks in H205 as fears of higher interest rates dampening the Irish consumer took hold. We anticipate a minimal impact from higher rates on the Irish consumer given disposable income prospects, the modest nature of any rate moves and the SSIA roll-off, which is a €15-16bn insurance policy on this sector of the economy.
Being overweight the financial stocks translates into Buy recommendations on AIB Group, Bank of Ireland and Anglo Irish, though the latter is not really an Irish story per se. We like the two big stocks in particular given the most obvious way of playing the Irish economy, while the strong share price showing of Anglo Irish in December may take some sting out of its Q106 performance. We have a Reduce recommendation on Irish Life & Permanent, since we think it has already priced in many of the SSIA related gains, and an Add on both FBD and IFG.
Focusing on our two key picks, AIB probably represents the best Irish play on both the resurging Irish consumer and the buoyant commercial sector, particularly commercial property lending. Having got to parity with European banks (11.2x vs 11.6x for the sector) over the last 12 months, we believe that AIB can move to a premium in 2006 (15 per centpremium) to ?20.7, underpinned by its Irish and UK business banking interests, which drive average 11 per cent EPS growth in 2006 and 2007, twice that in the wider sector.
In late Novermber’s finals we saw the first EPS upgrade at BOI in around three years. This now sees EPS growth average 13 per centat BOI for FY07 and FY08 and is beginning to look attractive. This is also well in excess of UK peers, against which it has recently de-rated. BOI (10.1x prospective earnings) should be trading at a premium to the UK sector, underpinned by the 70 per cent of profits from Ireland and it’s probably the more exposed of the large Irish banks to the SSIA theme. BOI’s capital position is weaker than AIB’s, but a possible hybrid issue in the short term may alleviate immediate capital generation concerns. This implies BOI moves to at least a parity rating with European banks in 2006.
Job Langbroek, Energy & Resources analyst, Davy Stockbrokers
We believe that commodity prices will remain at historically high levels in 2006 and that the prolonged upswing in the commodity price cycle will serve to support the valuation of the companies we follow. A jump in the share price of these resource stocks will come with successful results from the busy operational programmes. At first glance, we anticipate high-impact activity in 2006 to be most notable from Tullow, Island Oil and Gas, Petroceltic, Glencar, Ormonde and Kenmare.
The forces which drove commodity prices higher in the past two years have not abated in the past year. Taking oil as an example, there has been no significant geopolitical change, which would suggest that the security premium included in today’s oil price will erode in 2006. Furthermore, many issues which have propped up commodity prices are fundamental in nature and have no quick-and-easy solution. Again in the case of oil, spare capacity remains a problem. All of the world’s spare capacity is in the hands of OPEC and this is expected to remain the case for the foreseeable future as other major producing regions are believed to have peaked or to be in decline. The fact that OPEC has control over global spare capacity means it is the linchpin on the supply-side of the equation and can set the price floor. In this context, it is interesting to note recent comments from a number of OPEC members suggesting that the cartel will resist the oil price falling below $40/bbl.
We remain comfortable with the price assumptions we use in our valuation models. Our long-run price assumptions are as follows: $40/bbl for oil, $400/oz for gold and $2,750 per tonne of copper.
John Mattimoe, Small & Mid-Caps analyst, Merrion Stockbrokers
Most of the strongest performances in the Irish market over the past three years have been delivered by mid-cap companies. The strong performances since the end of the last bear market were driven by strong earnings growth over the period since and re-rating from the low valuation levels that persisted in early 2003. In 2005, the strong performances of quality Irish mid-cap stocks were very much skewed towards Q1. Many of these companies delivered very high returns in Q1, but valuations became less compelling as a result. Over the rest of the year, these stocks either surrendered a portion of the Q1 gains or experienced some de-rating reflecting earnings growth against a relatively static share price. With quality Irish mid-caps projected to continue to deliver further robust earnings growth, valuations are now more attractive again, indicating potential for good returns in 2006.
Grafton was impacted during the year by the negative trading statements from its UK peers such as Travis Perkins and a weakening UK consumer environment. While Grafton’s earnings proved robust due to a strong Irish market, the negative sentiment over UK conditions weighed on the share price. The sector has started to recover so we continue to like Grafton at this point though evidence of a turn in UK consumer confidence may be needed to allow re-rating. Kingspan looks set to continue to build on its strong track record with further growth next year as its markets continue to benefit from conversion to higher specification insulation products and offsite construction methods. Independent News and Media looks interesting as a play on the Irish economy as well as a vehicle for getting exposure to South Africa and more recently India.
Paddy Power plc is the ‘gamble’ of the bunch as the stock recovers from the impact of the recent profit warning and grapples with the issues which led to it - an unfavourable run of racing results and an increasingly competitive retail environment in Ireland, though Finance Minister Brian Cowen has addressed the betting tax issue in the budget. Prospects for the stock will also hang on the performance of the new CEO Patrick Kennedy who as his first priority must appoint a finance director to replace Ross Ivers who stepped down in November.
These six stocks represent our best picks of the mid-cap sector which collectively we expect will deliver an attractive average return in 2006. |
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| Article appeared in the January 2006 issue.
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