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Beaufort Securities Breakfast Today including Direct Line, Auhua Clean Energy and Inchcape

Beaufort Securities Breakfast Today including Direct Line, Auhua Clean Energy and Inchcape

The Markets

Market opening: Markets are likely to open higher today. FTSE 100 futures were trading 0.5 points up at 7:00 am.

New York: Wall Street ended slightly higher as weak payroll data increased hopes of a milder reduction in or postponement of the cut-back in the Fed’s monetary stimulus programme. Energy sector was the laggard, driven down by weak earnings data from Chevron, while consumer discretionary and materials sectors provided support. S&P 500 closed 0.2% up.

Asia: Markets slid on weak US jobs data and lower-than-expected corporate earnings report from Toyota Motor and Hitachi Zosen. Nikkei ended 1.4% lower. Hang Seng was trading marginally up with 0.2% gain at 7:00 am on the People’s Bank of China (PBOC)’s assurance related to China’s economy.

Continental Europe: Equities traded mixed as increased speculations over the potential impact of US jobs data failed to provide proper direction to the markets. Insurance companies led the gains on strong results from insurance giants such as AXA and Allianz. France’s CAC 40 rose 0.1%, while Germany’s DAX edged down 0.1%.

UK small caps: The FTSE AIM All-Share index rose 0.2% on Friday

Today’s news

China’s service sector PMI stable in July

The Purchasing Managers’ Index (PMI) for China’s service sector remained at 51.3, unchanged from previous month, the data released by HSBC showed today. However, the composite PMI including both manufacturing and services declined to 49.5 in July from 49.8 in June. As per the official data, service sector PMI rose to 54.1 from 53.9, whereas the manufacturing PMI advanced to 50.3 from 50.1 in last month.

Japan’s service sector growth slows in July

Japan’s service sector PMI lowered to 50.6 in July from 52.1 in June, as per the data revealed by Markit Economics. The composite index also dropp

Company News

Auhua Clean Energy (LON:ACE)

On Friday Auhua announced to the market that its wholly-owned subsidiary, Auhua Holdings Limited, had entered into a Heads of Terms for the acquisition of the business and assets of two related companies, Ziolar Pte Ltd and Taiwan Ziolar Technology Co. Ltd, for a total consideration of US$4.5m. This will be satisfied by a total allotment and issuance of 11,727,022 new, locked-in, Auhua shares at 22.5p each plus a convertible loan note for an aggregate sum of US$0.5m with 6 months term, whereafter it can be redeemed or converted into 1,465,878 further new Auhua shares (also at 22.5p) at the holders’ prerogative.

The announcement is one of the new technological initiatives Auhua has been examining for some time and referred to in Beaufort’s most recent research publication (16th July 2013). Potentially this acquisition is ground breaking not just for Auhua but, on a longer view, for the solar thermal industry as a whole. The technology is young, needs to undergo larger scale trials and is only now in the process of securing its intellectual property. Auhua’s management, nevertheless, recognises that its successful adoption could quite dramatically increase system efficiencies and result in a reduction panel size. In so doing, Auhua appears to have found a way to retain its leading position in Chinese split-unit solar thermal technology as well as offering something new to its prospective international customer base.

Whereas Auhua’s past research and development has centred on the solar water heater tank, Taiwan Ziolar’s focus has been on the thermal panels. Its mission is to apply advanced thin film coating technology to develop integrated, high performance, low cost thermal collectors. Although the commercialisation of such products frequently suffers unexpected delays, management remains confident of its ability to start incorporating the new technologies into its next generation of split-units within 12 months. Key strategic benefits of the acquisition include:

- Enhanced system performance. The new Auhua stainless steel panel with integrated PVD selective coating that increases system efficiency by 40% and provides superb performance during cloudy or cold weather.

- Reduced cost structure. Driven by high efficiency and integrated product design, the per kW cost of the improved Auhua panel is expected to be 30% lower than traditional technology.

- Compact panel size. Improved efficiency leads to smaller installation size and wind resistance that could be better accommodated on high rising buildings than more traditional panels.

- Accelerated innovation. The anticipated pooling of the combined research and technology will help to streamline product development and better address the evolving needs of this dynamic industry.

The deal is presently at the ‘Heads of Terms’ stage and definitive agreement is expected to be entered by the parties no later than end-August. Assuming these new technologies can be successfully adopted, and that their integration does not significantly alter the economics of production/maintenance, the ramifications have the potential to go far beyond Auhua itself. One should bear in mind that while technological innovation has not significantly impinged on the solar thermal panel over the past decade, such green power initiatives, often incentivised by governments, have become a multi-billion dollar global industry. A report published by the International Energy Agency (2009), for example, estimated that solar thermal generation amounting to 172.4 gigawatt thermal (‘GWth) was in operation worldwide at end 2009, being dominated by China which accounted for 101.5 GWth of the total. It went on to state that the IEA “Energy-efficient Buildings: Heating and Cooling Equipment” roadmap projects that solar thermal capacity in the building sector could increase by more than 25 times to reach 3740 GWth by 2050. Whereas the most common application of solar thermal collectors today is in the building sector, applications in solar (thermal) cooling and industrial process heat are also very promising. Clearly, given the scale of the evolving industry, any groundbreaking technology capable of raising panel efficiencies by 30% or more will become highly sought after. Quite separately from its core split-unit water heater business, the licensing opportunities for this new technology for Auhua alone could be huge.

Direct Line Insurance Group (LON:DLG)

Direct Line Insurance Group released its half yearly report on Friday. In H1 2013, the ongoing operations yielded £1,975.9m of gross written premium, down from £2,058.4m in the same period last year. The decline was largely a result of increased competition in UK personal lines even though the International segment provided support. Net earned premium dipped to £1,772.3m from £1,860.8m. However, operating profit from ongoing operations surged 27.8% to £286.6m, chiefly driven by lower claims from weather-related events and better cost control measures adopted by the company. Total operating profit advanced to £227.3m from £116.7m while the profit after tax rose to £151.8m from £82.8m. Combined operating ratio (COR) for ongoing operations stood at 94.6% versus 101.1% in H1 2012 owing to an improvement in the underlying loss ratio and continued reserve releases. However, commission ratio increased to 11.3% from 8.4%. Net asset value per share was 186.9p, while tangible net asset per share stood at 156.6p, compared to 189.1p and 161p, respectively, at the end of 2012. Annualised return on tangible equity from ongoing operations was 17.3% versus 10.2% during H1 2012. Basic EPS rose to 10.1p from 5.5p last year. In Q2 2013, the company launched a telematics product in June as a part of customer proposition improvement. In March 2013, RBS Group placed a second tranche of 251.4 million shares in Direct Line Group with institutional investors, lowering RBS Group’s shareholding in Direct Line Group to 48.5%. The company announced further cost-saving targeting a cost base of £1bn in 2014 and is on track to meet the COR target of 98% after normalisation for 2013.

Our view: Direct Line Group delivered a resilient performance despite competitive pressures in the UK personal lines and lower investment returns. The company announced a massive jump of 27.8% in operating profits from ongoing operations for H1 2013 as favourable weather conditions led to a significant reduction in the number of claims. The profit after tax came 83.3% higher. The company made a considerable progress on the cost-reduction front as well. In June, Direct Line had announced job cuts of around 2,000 in order to achieve its cost targets for 2014. Furthermore, the legal reforms announced by the British government in April are likely to aid in further reduction of the claims’ cost for the company. Considering the above along with the growth in the International division, we upgrade our rating on the stock to a Buy.

Inchcape (LON:INCH)

On Friday, Inchcape released its half year results for the period ended 30th June 2013. Group’s sales rose to £3,312.9m from £3,108.7m while like-for-like (L-F-L) sales grew 2% against 6.8% last year. Retail sales increased 10.4% to £2,025.1m while Distribution sales inched up 1% to £1,287.8m. Total trading profit edged up to £167.1m from £150.3m with a 0.2% dip in Retail division and 17.1% jump in Distribution division. About 70% of the trading profit came from the geographies of Asia Pacific and the Emerging Markets. Australasia segment recorded a 19.1% increase in sales to £736.3m with trading margins of 5.7%. Sales from the Europe segment including Belgium, Luxembourg, Greece and Finland declined 3% to £331.1m with trading margins of 3.1%. UK sales advanced 5.1% to £1,141.5m with trading margins of 3.3%. In Russia and Emerging Markets, sales were up 3.8% to £664.7m with trading margins of 5%. Overall trading margins improved to 5% versus 4.8% last year. Earnings per Share (EPS) rose 2.4% to 21.2p. The company declared an interim dividend of 5.7p against 4p last year. The company also announced a share buyback programme of £100m to be achieved in the next 12 months. Inchcape acquired a leading luxury and premium automotive group, Trivett Automotive, based in Australia, in March 2013 for £76m. The management expects the company’s performance to remain strong for 2013.

Our view: Share buyback of £100m could be a good value addition for the investors of Inchcape. The company delivered a solid performance across the Australasia segment including Australia and New Zealand. The company managed to deliver a reasonably strong performance even as a competitive scenario in the vehicles segment pulled down the segmental margins. Recent acquisition of the Australian company has added to the revenue base of the company. However, performance in some of the geographies has not been up to the mark. Additionally, the Russian markets are expected to see a drop in the margins on a weaker demand. These negatives somewhat offset the upside offered through the announced buyback. Besides, considering the past performance of the company, the stock has appreciated nearly 45% from the beginning of the year till date. We therefore believe that Inchcape does not offer much scope of further appreciation in the near future and recommend a Hold rating.

Red Rock Resources (LON:

On Friday, Red Rock Resources announced that its 39% owned associate company, Resource Star (RSL), has entered into a binding term sheet agreement with Searex Petroleum for acquiring an oil project in Abilene, Texas (US). As per the term sheet, RSL would acquire a 50% shareholding in D-Bar Leasing holding 100% working interest in eight oil producing leases spread over 2,732 acres with 10 acres of freehold land and buildings. The lease houses about 96 wells. D-Bar has recently completed the rework programme for four of these wells with current depth of 2800′-3000′ production level of 15 barrels of oil per day (bopd). D-Bar plans to do rework for 80 wells with additional drilling aimed at increasing the production level. For funding the deal, RSL plans to issue 65 million new shares and 41,000 performance shares alongside a cash payment of AUD1m. Each performance would get converted to 10,000 RSL shares upon completion of set milestones. The deal is conditioned upon raising of a minimum US$5m through high yield debenture notes, completion of successful due diligence by RSL and the approval from regulatory authorities and the shareholders of RSL.

Our view: The acquisition of Texas oil project by Red Rock’s associate company, RSL, is positive news for the investors. RSL’s performance in the recent past had been subdued because of the poor market conditions for Uranium. The group also has other assets including a gold mine in Colombia and a gold and copper exploration in Kenya. Though the current piece of news is favourable for Red Rock, the completion of the deal is still subjected to the regulatory approvals and most importantly, the approval from the shareholders of RSL, whose stake would get diluted as a result of the deal. We, therefore, assign a Hold rating for the stock.

Economic News

UK Nationwide house prices

UK house prices rose 0.8% m-o-m in July after edging up 0.3% in the previous month, as per the data released by Nationwide Building Society last Friday. Economists had expected a milder increase of 0.4% in the prices. On y-o-y basis, prices advanced 3.9%, at the strongest pace since August 2010, following an increase of 1.9% in June while economists had projected a rise of 3.1% only. The average price of a house in UK inched up to £170,825 from £168,941.

US change in non-farm payrolls and unemployment rate

US non-farm payrolls increased by 162,000 in July from a revised reading of 188,000 in June, the US Labor Department said on Friday. Economists had expected a reading of 185,000. The unemployment rate inched down to 7.4% from 7.6% in June against the market expectation of 7.5%.

US personal income and spending

US personal income edged up 0.3% m-o-m in June following a downwardly revised growth of 0.4% in May, the Bureau of Economic Analysis revealed on Friday. Economists had projected the income to move up 0.4%. Personal spending rose 0.5% in June, in-line with the market estimates, after advancing a revised 0.2% in May. After adjusting for inflation, spending inched up 0.1% following a similar increase in May.

US factory orders

US factory orders advanced 1.5% m-o-m in June following an upwardly revised gain of 3% in May, the US Department of Commerce said on Friday. Economists had projected factory orders to rise to 2.3%. The June orders stood at US$496.7bn, moving up US$7.6bn from the previous month. The increase was mainly due to a 12% surge in the demand for transportation equipment. Excluding transportation, orders dipped 0.4% after an increase of 0.1% in the previous month. Orders for durable goods rose 3.9% while orders for non-durable goods, including petroleum, fell 0.6%.

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