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Looking for value in the equity market Back  
In the light of recent market wobbles, value shares are all the more needed. Finance magazine asked the award winners of the recent Finance Magazine stockbroking survey what shares are likely the perform over the coming year.
Eamonn Hughes, 'Best Financials Analyst', Goodbody
After a strong 2006, we anticipate more modest gains in the Irish financials in 2007. The main topics likely to dominate the horizon are the peak in the interest rate cycle and credit, the domestic (and US) housing market and capital levels. Our preferred large cap bank is AIB and we also like Anglo Irish given its structural growth prospects in the UK and US. However, we would only be anticipating circa 15 per cent total return from each stock in 2007.

The market is pricing in 4 per cent interest rates from the ECB by the summer. While we think the Irish consumer can deal with this, it won't help sentiment if this number was to move higher. Nevertheless, the fact that we are approaching the peak in rates, without undue stresses on the domestic economy, removes one of the sticks global strategist's used to beat up the Irish banks in 2006 (we still outperformed the E300 banks index). This should help leave the Irish banks on investor's radars in the year ahead.

While obvious risks continue to face the US or UK consumer, we feel reasonably confident the Irish consumer remains in good shape again in 2007. The bulk of the SSIAs unravel this year and savings rates remain high. Also, stronger economic momentum coming into the new year than originally envisaged must have positive repercussions at the employment level. Corporate balance sheets domestically look healthy with D/E ratios in the small mid-cap sector anticipated around 40-45 per cent at end 2007 and a near 9x interest cover. So it's hard to get too concerned about domestic corporate credit quality at this juncture.

On housing, with the weak auction results in autumn last year at the top end of the market and resolution of some uncertainty about stamp duty in the Budget, the opening of the spring auction season will be closely watched by observers. Our gut feel is that although risks have undoubtedly increased in 2006, the property market is still fundamentally underpinned by employment growth, immigration and the likely peak last year in supply.

On capital levels, January 1 marked the commencement of the new Basle II rules. Saying that, the impact is muted, since the banks firstly run the old and new rules concurrently in 2007, then any benefits are heavily discounted in 2008 and 2009. Irish bank balance sheets are among the most leveraged in Europe, so this is one area investors will be watching closely. The stronger capital base at AIB underpins our preference for this stock over Bank of Ireland.

Finally, its hard to envisage any progress on M&A in 2007. Firstly, Irish banks don't offer most European or US corporates a major strategic play on Europe. And, secondly, the structural growth story in Ireland is not as attractive as it used to be, with the consumer now sitting on debt to disposable income ratios of close to 160 per cent.

Gerry Hennigan, 'Best Technology Analyst', Goodbody Stockbrokers
The pace of change within technology ensures a constant state of flux, which in turn results in a plethora of markets within the one sector, each at a different stage of evolution. Applying a top-down approach from an investment perspective is hence open to error, in our view, as it ignores diversity, individual market maturity and growth characteristics. This is particularly relevant to the smaller cap stocks, a category within which all of the indigenous Irish technology companies fall.

That said, common themes that can be broadly applied across the sector include: (i) the strength of corporate spending activity; (ii) currency fluctuation and; (iii) seasonality. Recent years have seen corporate spending on technology in the low to mid-single digit growth range, an environment that tends, in our view, to favour the larger vendors and we believe that 2007 is shaping up in a similar vein.

Market innovation provides opportunities for the smaller cap stocks and while less apparent in a broad sense it is more evident in selected niche markets. Such opportunities form a central tenet of our stock selection and indeed have been apparent in the recent performance of companies such as Norkom. It has benefited from regulatory pressure on financial institutions forcing them to comply with legislation in areas such as anti-money laundering. Andor, too, has benefited from innovation, in this case technical innovation and the expanding markets to which its technology can be applied. We expect both to continue to benefit over the coming year.

Most of the other indigenous technology companies - Datalex, Horizon, IONA, Trintech, etc. - operate in more established markets. All have experienced significant restructuring and indeed in the case of Horizon and Trintech continue to restructure, both having divested material portions of their businesses in the past few months. Datalex should benefit in the coming year from a transition towards transaction based sales while IONA, following years of revenue decline, is experiencing renewed growth as momentum behind the SOA initiative in software integration gathers pace. Dollar depreciation and seasonality were factors, in our view, behind the recent out-performance of the technology sector.

The former favours those companies reporting in dollars but with exposure to non-dollar denominated revenue streams. Datalex, IONA and Trintech would fall into this camp, albeit that the benefit is dampened by a cost base weighted in euros. Seasonality tends to derive as a consequence of corporate budget cycles and is thus weighted towards the second half of the year, and among the indigenous companies is most evident in the case of IONA.
In summary, we believe that each stock should be looked at primarily from the perspective of its individual market characteristics, and in that regard we would highlight Andor and Norkom for the year ahead.
John Sheehan of NCB Stockbrokers lining up his awards: 'Analyst of the Year', 'Best Construction Materials Analyst' and 'Best Small & Mid-Cap Stocks Analyst'.

Gavin Kelleher, 'Best Gaming Analyst', 'Best Media Analyst', Goodbody Stockbrokers
Paddy Power performed solidly during 2006, with its share price increasing 24.4 per cent. While this slightly lagged the performance of the overall ISEQ, up 27.8 per cent, it has to be viewed in the context of the overall gaming sector, which was seriously impacted by US legislative changes introduced in September 2006. In fact, Paddy Power's performance highlights its envious position among its peers of having no US exposure while being predominantly focused on markets where the threat of regulatory changes are minimal. Looking ahead, from a sector perspective, the key themes during 2007 are likely to be: (i) continued regulatory concerns; and (ii) consolidation in the sector. The key factor that sets Paddy Power apart is that it offers investors exposure to online gaming growth, with little or no regulatory threats, while having a solid traditional betting business with growth potential underpinning its model. The first opportunity during 2007 to judge Paddy Power's operational performance during the year will most likely be its preliminary results, which are due out on March 5th.

In terms of its key growth drivers, the group's online division should have performed strongly during the second half of 2006 and we expect this can continue into FY07. The growth outlook for the online division is underpinned by: (i) increased broadband penetration; (ii) the impressive growth in active users that it reported with its interim results in September 2006; and (iii) the group's multi-product differentiated offering. Outside the group's online division, its Irish retail estate is also a key growth driver This was more than highlighted by its performance during the first half of 2006, when it reported a 13.2 per cent rise in operating profit to ?9.7m, despite incurring a one-off cost of c.E4 million in relation to the group's move to tax free betting before it was introduced in July 2006. This cost will not have been an issue during H2'06 and into FY07, so an improved operating profit performance is likely. Furthermore, the growth in the Irish estate is also underpinned by: (i) its market leading position; (ii) the positive economic backdrop; and (iii) its solid organic growth strategy. In terms of the UK, while Paddy Power's 60 shop UK estate is currently loss making, there were a number of encouraging signs during H1'06 that showed a profitable UK estate is achievable in the medium term, The group is continuing to see growing acceptance of its brand in the UK. In addition, the first 30 shops opened by the group in the UK reached EBITDA positive during H1'06.

In summary, we believe Paddy Power should continue to deliver in 2007 and it is in a strong position to outperform its peers. Furthermore, any investment case in the stock is underpinned by the group's strong financial position, which leaves it well funded for further growth.

Media: During 2006, Independent News and Media performed strongly, up 18.1 per cent, outperforming the European media sector, which increased 7.3 per cent. While Independent News & Media's diversified divisions performed solidly during 2006, the key reason behind its strong out-performance was the increase in the valuations of Australian media assets and the announcement that it was planning to realise value from its APN stake through a leveraged buy-out with a private equity partner. In terms of the outlook for 2007, Independent News and Media finds itself well placed to again outperform its peers. Firstly, it has a highly attractive portfolio of diversified media assets. Secondly, there is the possibility that at some stage in the year the group will realise significant value from its 40.8 per cent stake in APN.

The group has market leading positions across most of the media markets it operates in, both in developed economies such as Ireland, UK and Australia/New Zealand, and developing economies such as South Africa and India. During 2007, the group's Irish operations should benefit from a strong advertising market due to the SSIA release and the General Election, which is likely to be held between April and June. In the UK, while the advertising market remains difficult, there have been encouraging signs that a change in the UK Independent's fortunes could be a possibility into FY08. In terms of Australasia, while growth rates have slowed, APN should continue to perform solidly. Finally, South Africa should remain the star performer of the group, due to the expansion of the South African economy, along with positive factors such as rising literacy rates and an ever-increasing middle class.

In relation to the possibility of a leveraged buy-out of APN, while the group announced that its proposed deal with Providence Private Equity Partners had collapsed, it is still widely believed that another private equity deal is a definite possibility. Assuming a new deal takes a similar structure, we estimate that the group could realise in the region of E350 million-E500 million.
Overall, INM is in a prime position to continue to outperform its peers, which should be helped by the fact that it is forecast to deliver solid earnings growth over the medium term. Further support for the share price could come from its highly attractive dividend yield and the possibility of the group realising significant value from its APN stake.
Due to corporate activity Goodbody Stockbrokers is restricted from commenting on UTV.

Robert Brisbourne, 'Best Pharmaceuticals & Biotechnology Analyst'/'Best Food & Beverages/Agribusiness Analyst', Merrion Stockbrokers
Pharmaceuticals & Biotechnology: Looking back at 2006 it was a mixed year for the Irish healthcare companies. ICON was the strongest performer of the group with over 80 per cent increase in the share price on the back of a strong earnings recovery. Elan and United Drug were more stable with share price increases of 5 per cent and 8 per cent respectively. Elan successfully went through the process (with Biogen) of getting Tysabri through the FDA safety review and back to market. United Drug had another solid year with continued double-digit EPS growth despite taking on the extra costs of moving to new facilities at Magna Park II.
Looking forward to 2007 it is Elan that has the greatest potential (and also risk) with some key milestones that will be crucial to the future prospects of the group. With Tysabri only newly on the market in 2006, progress in 2007 will improve clarity on what the true potential is for Tysabri in MS. In addition there will be further news on the Alzheimer's disease pipeline. The most important development (from a group valuation perspective) will be with AAB-001 which is currently in Phase II trials. Elan management have indicated that they expect AAB-001 to move into Phase III trials during 2007. This in itself would be a very important development for the group given the huge potential market for a successful Alzheimer's drug. In addition there is also likely to be progress with various other compounds within Elan's multifaceted approach to Alzheimer's disease. Significant success with either Tysabri or the Alzheimer's disease pipeline could drive considerable out-performance from Elan shares after a weak start to the year. However, we note that visibility (particularly regarding the Alzheimer's pipeline) remains low hence our HOLD recommendation on the stock.

We expect 2007 to be a less dramatic year for ICON and United Drug with both companies expected to continue with strong organic growth. We are forecasting 30 per cent EPS growth at ICON with continued progress on margins combined with good organic sales growth. United Drug is set to deliver its 22nd consecutive year of double-digit EPS growth despite the reduction in drug pricing in Ireland (where an alternative generic drug is available) which will impact growth in the wholesale and supply chain services divisions.

Food and Beverages: 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 2007 will be very different.
The top performer in the food and beverages sector in 2006 was C&C Group, which appreciated by over 40 per cent in 2006. The key driver of the C&C share price has been the success of Magners cider in Britain. Another year of strong volume growth is expected from Magners in the current year. That said, Magners this year appears to have had a greater seasonal decline this winter than we previously expected (likely due to the extremely hot summer in 2006). As a result we have tempered our recommendation on C&C from a BUY to a HOLD pending improved visibility of a recovery in the spring/summer months of 2007.

IAWS also had a very strong share price performance in 2006 (up by 50%) due to a combination of solid organic growth, a well received acquisition (Otis Spunkmeyer) and increased focus on the monetisation of the land bank. Following a considerable re-rating in 2006 it is difficult to see IAWS replicating such a strong share price performance in 2007 but IAWS remains a strong company with very good medium term prospects. Kerry had a challenging year in 2006 with downward revisions to profit expectations as a result of very high energy prices that weighed on group margins. Looking to 2007, energy prices have declined significantly and should be much more manageable although this benefit will be offset (to a degree) by the increase in price of soft commodities. In order to drive strong shareholder returns in 2007 a recovery in growth at Kerry back towards historical double-digit rates is likely to be required. Glanbia will also be seeking an improvement in growth in 2007 with the most severe impact of EU dairy reforms now in the past and the acquisition of Seltzer adding to growth.

For Greencore and for Fyffes 2006 was a year of transition. Greencore now derives over 80 per cent of group profit from its convenience foods business following the exit from sugar processing. With a consistently performing convenience business it is progress towards realising value from Greencore's various land assets that is likely to be the key driver of shares performance during the year. Fyffes is now focused on its Tropical Produce business following the demerger of property assets into Blackrock, and more recently the demerger of its general produce business into Total Produce plc. Regulatory change in the European banana business in 2006 caused a major decline in profit. Going forward banana profits may continue to be volatile. Fyffes fixes its banana purchasing costs in advance so the level of banana prices when sold in the market is likely to be the key driver of profit (and share price performance) for Fyffes in 2007.
Taking all these factors into account it is difficult overall to envisage the food and beverage sector in Ireland having such a strong performance in 2007 as was achieved in 2006.

John Sheehan, 'Analyst of the Year', NCB Stockbrokers
Finally Time for the Large Cap Outperformance? Irish equities rallied strongly in the second half of 2006 as concerns eased that commodity price driven inflation would necessitate sharp interest rate hikes. Having been ahead by a modest 2.1 per cent at the half-year the ISEQ gained 25.7 per cent in the second half to record a full year advance of 27.8 per cent.

A 2006 equity market gain of 27.8 per cent, following gains of 23.2 per cent, 26.0 per cent and 18.8 per cent in 2003, 2004 and 2005 respectively represents a high benchmark but we view prospects for 2007 as favourable. Gains in 2007 may not match those of 2003-2006 but the corporate earnings outlook remains positive, supported by an economic backdrop that is buoyant in Ireland (projected growth of 6.6 per cent) and a broad acceleration in the economic recovery underway in Mainland Europe. The recent rate rise in the UK surprised markets but we continue to expect growth in excess of 2 per cent, while recent Fed comment points to ongoing US expansion, despite the slower housing market.

Earnings growth in the Irish market consistently exceeded expectations in 2006 and led to a continued stream of upgrades. We see this as reflective of i) a positive economic backdrop ii) effective market communication as companies generally under-promise and over-delivering and iii) continued implementation of proven growth (organic and acquisitive) to create value and augment earnings. These factors remain firmly in place entering 2007.

The Irish equity market trades on 13x 2007 forecasts, a level we consider attractive relative to other asset classes such as property, bonds and cash. We expect earnings growth to be the main driver of stock prices in 2007, with scope for some re-rating among the larger caps. Earnings growth of 13 per cent, allied to a projected yield of 2.1 per cent, constitutes a favourable market outlook.

Despite the strong second half market performance in 2006, the market re-rating has been limited to certain stocks. In particular the Irish financials, CRH and Ryanair are on generally lower two-year forward earnings multiples than in January 2006. Contrary to perceptions, the market's largest constituents are therefore generally less expensive than in January 2006.

Risks centre on a global economic shock but the global slowdown of 2002 saw the Irish economy continue to expand, albeit it a reduced rate of circa 3 per cent. This testified to the internal dynamic currently powering the economy.

Merger and acquisition activity will remain a major support for equity valuations in 2007. Private equity fund-raisings have set new records in 2006 and will, for now at least, be augmented by an abundance of cheap debt. The growing incidence of liability driven investment is also likely to underpin the debt markets as investors continue their pursuit of yield.

Our top five 2007 selections are Allied Irish Banks (attractive valuation and strong growth), CRH (US worries overdone and exposure to recovering Mainland Europe), Ryanair (material yield and fuel cost upside to earnings), Irish Life & Permanent (mortgage market concerns overdone and the purest play on Ireland) and C&C (Magners formula to continue to deliver).

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