German bank Berenberg has had a dekko at the builders’ merchants sector and downgraded Travis Perkins PLC (LON:TPK) and upgraded Grafton Group PLC (LON:GFTU).
Spending on repair, maintenance and infrastructure (RMI) in the UK is likely to be flat at best in 2018, the bank believes, so although the sector’s valuation looks cheap in historical terms, Berenberg sees limited catalysts for a re-rating, beyond a broader recovery in equity markets generally.
READ: Travis Perkins says on track to achieve full year expectations despite challenging market backdrop
It sees three key drivers of earnings momentum in 2018: geographic diversity; investment in a differentiated UK branch network; and a strong balance sheet.
On these bases, its top pick in the sector is Grafton (ISE:GFTU), which it has upgraded to ‘buy’, with a price target of 920p – 133.5p above the current share price.
The bank has had a change of heart on Grafton since the Irish company’s trading update last month.
Around 32% of the company’s underlying earnings (EBITA) come from Ireland and the Netherlands, while its Selco business is growing rapidly, leading Berenberg to believe positive earnings momentum will persist.
“The upgrade to EBITA guidance in the group’s January trading statement and the strong lfl [like-for-like] growth delivered in its UK merchanting business has made us reassess our view and we believe that the risk/reward trade-off is now more favourable,” Berenberg said.
READ: Grafton Group's Leyland SDM purchase "a very sensible deal", Numis says
As for Travis Perkins, it continues to believe the company will be a long-term winner in the UK general merchanting space, supported by its investments in its supply chain, but in the nearer term, it is put off by the merchant’s total focus on the UK market.
The stock is downgraded to hold, with a price target of 1,550p; the shares currently trade at around 1,420p.
SIG PLC (LON:SHI), meanwhile, is left at ‘hold’, with a price target of 160p.
“Following the group’s capital markets day at the end of 2017, we are more confident in management’s ability to reduce the cost base; however, we believe the current share price fairly reflects the speed at which this can be achieved,” the bank said.
Also left on ‘hold’ is Howden Joinery Group PLC (LON:HWDN), despite it having the strongest balance sheet of the four companies under review.
As with Travis Perkins, Berenberg is put off by the company’s near 100% UK exposure.
“The group remains a quality operator and is outperforming peers, but we believe this is reflected in current valuation,” Berenberg opined.
Its valuation of Howden is 450p, 17p below the current share price.