The Markets
Market opening: The FTSE-100 is expected to open around 14-points lower this morning.
New York: Wall Street ended in the green after a volatile trading session yesterday. A rebound in biotechnology stocks and rally in materials shares lifted investor sentiment. The S&P 500 advanced 0.8%, with the healthcare sector gaining the most.
Asia: Equities are trading lower. The Nikkei 225 fell 1.0% on lower-than-expected data on machinery orders for August. The Hang Seng was trading 1.0% down at 7:00 am.
Continental Europe: Markets closed higher, led by gains in mining and auto stocks. Investors largely ignored weak German industrial production data. Germany’s DAX and France’s CAC 40 rose 0.7% and 0.1%, respectively.
Crude Oil: Yesterday, WTI and Brent oil prices decreased 1.5% and 1.1%, respectively. The spread between the two varieties stood at US$3.5 per barrel.
UK small caps: The FTSE AIM All-Share index closed 0.02% lower yesterday at 733.41.
Today’s news
UK house price balance eases in September
As per the Royal Institution of Chartered Surveyors, the monthly house price balance in the UK fell to +44 in September from +53 in August, below the market expectation of +55. The drop was largely due to a decline in the sale of properties despite a large number of properties being available in the market.
Company News
Strat Aero (LON:AERO) – Hold
Strat Aero plc, the international aerospace company focused on the rapidly emerging Unmanned Aerial Vehicle (‘UAV’) sector, yesterday announced that it has reached agreement on a joint venture arrangement with UAV Airways Limited. UAVAir is a privately owned company which, as a UK CAA Approved National Qualified Entity, specialises in the provision of UAV training, including qualifying future UAV pilots. The Joint Venture (which will be provisionally known as UAVAir by Strat Aero), will be aimed at establishing future Remotely Piloted Aircraft & Systems training centres and delivering RPAS training courses in territories overseas. This is part of the Strat Aero’s strategy to build rapidly a vertically integrated UAV offering, covering all aspects of the value chain including software, hardware and services and the Joint Venture follows the recent acquisition of Geocurve Holdings Limited, which specialises in the provision of UAV operated topographical surveys and inspection services to a blue chip customer base.
Our view: UAVAir is the second in a series of strategic transactions Strat Aero’s new management team has been evaluating, all of which have the potential to fast track the Group’s transformation into the first fully integrated global solutions provider focused on the rapidly growing UAV market. The combination of Strat Aero’s existing training business combined with the technical knowledge and training reputation of UAVAir from its streamlined 3-day integrated course could win over businesses across multiple areas. As such the JV is intending to position itself at the forefront of this rapidly expanding part of the UAV sector. This transaction allows matching of existing military training capability with the potentially much bigger civilian market opportunity, which appears set to become a long term education market with worldwide jobs being created in tandem with the advance of UAV and related technologies. It will also help Strat capture a wide range of skills and visions from early movers that are helping shape this rapidly developing industry. And there can be absolutely no doubt that the global market opportunity already identified will become absolutely giant. The US administration, for example, is presently taking steps toward an opening of US airspace for Unmanned Aerial Vehicles, from which the Federal Aviation Administration suggests a new market worth as much as US$100bn could eventually be created in its territory alone. Of course, actually converting identified interest and enquiries into firm, near-term profitable contracts is, as Strat’s previous management found out to their pain, the trickiest part – especially when dealing with military and utilities. The newly adopted more deliverable approach (focussing first on commercial applications) should therefore provide greater visibility for forward earnings. That said, shareholders need to be realistic about the immediate future and expect the Group to deliver losses, not just for the current year but also 2016E. Beaufort retains its ‘Hold’ recommendation in anticipation of Strat’s operational portfolio being built-out in the coming weeks/months and operational/revenue strategy becoming increasingly clear.
Beaufort Securities acts as corporate broker to Strat Aero plc
Horizon Discovery Group (LON:HZD) – Speculative Buy
Horizon Discovery Group plc, the international life science company supplying research tools and services that power genomics research and the development of personalised medicines, announced yesterday that its leveraged business unit has signed a programme in-licensing and option agreement with Servier, the independent French research-based pharmaceutical company. The agreement is potentially worth over £50m (US$76m) to Horizon in preclinical and clinical milestones, payments linked to net sales, and tiered royalties on future product sales. Horizon has in-licensed novel kinase inhibitors from Servier that exhibit great promise based on pre-clinical data for treatment of a range of cancer types but do not currently have a biomarker to define a sensitive patient population. Horizon will use its world-leading platform, comprising isogenic cell lines and in vivo models, CRISPR-Cas9 mediated gene editing technology and ultra-high-throughput combination screening, to identify the population of cancer patients most likely to respond to the in-licensed compounds, whether as single agents or in combinations with other drugs. Horizon also has the option to explore the use of the inhibitors in other therapeutic indications. Under the terms of the agreement, Servier has a first option to license back the assets. If Servier does not take up its option, Horizon will be free to seek another pharma partner and Horizon and Servier would then share in the success of the progression of the programme as it advances into the clinic and registration. Horizon will evaluate the mechanism of action of the candidate compounds, and will verify the patient stratification hypothesis by both in vitro and in vivo preclinical experiments. Horizon will also define a path towards the development of biomarkers for both patient stratification and drug efficacy. Mr Jean Pierre Abastado, Director of Oncology Innovation, Servier, commented: “The long standing collaboration between Servier and Vernalis has led to the discovery of novel kinase inhibitors. Horizon’s technology portfolio and expertise makes them ideally positioned to progress these drug candidates into the clinic and to investigate their potential for therapeutic efficacy both alone and in combination therapies. Servier is committed to driving therapeutic progress for the benefit of patients, with partnerships such as this playing a key role”. Servier had US$4bn revenue in 2014, with a strong presence in 146 countries. It is driven by the pursuit of innovation in the therapeutic areas of cardiovascular, metabolic, central nervous system, bone, muscle and joint diseases as well as cancer.
Our view: The in-license of assets with a strong pre-clinical pedigree but do not yet have a clear clinical development strategy, represents a great opportunity for Horizon. Demonstrating its scientific leadership through their translational genomics, drug combination and biomarker discovery platforms; the Company seek to identify genetic markers that predict drug sensitivity enabling programmes like this one to be progressed rapidly into the clinic for defined patient populations. This innovative deal, as part of Horizon’s strategy to drive accelerated growth, offers significant upside potential for investors built upon the leverage of our intellectual property, technology platforms and know-how. The shares have not performed well since the £25m new money placing at 190p in May, primarily because of an overhang. Woodford Investment Management participated and has over 11%. Ignore the perceived overhang and buy. The Company is undervalued.
Wood Group (LON:WG.) – Speculative Buy
Yesterday, Wood Group informed that it won a multi-million dollar contract from Bechtel, a US based construction firm. As per the deal, the company would offer automation solution including engineering, control hardware and remote instrument enclosures (RIEs) for Tengizchevroil’s (TCO’s) Crude Storage Capacity Project at the Tengiz Field located in Kazakhstan. The project would improve the capacity of the tank farm to facilitate the upgrading of the existing tank farm.
Our view: Wood Group continues to help TCO in the development and upgradation of its control infrastructure. Capitalizing on its technology know-how and capabilities in automation and controls, the company aims to deliver cost effective and viable solutions suiting requirements of TCO. Wood Group is undertaking various initiatives to mitigate the adverse impact of prevailing challenging market conditions. Recently, the company acquired Automated Technology Group (ATG), one of the UK’s largest independent suppliers of control and power solutions for industrial automation. ATG would provide a range of opportunities to the company’s Mustang arm comprising of development in automation business to include manufacturing and expanding into the food, beverage and airport markets. Furthermore, Wood has trimmed its workforce by 13%, reduced project costs and pushed for higher utilization. The company has entered into a large contract with Shell for five years to provide services to four onshore fields in Gabon, which would help to optimize costs and production across the assets in Rabi, Gamba, Toucan and Koula. Wood has also been awarded a three-year offshore engineering blanket order by PEMEX Procurement International for field development in Mexico’s Gulf of Mexico waters. We believe the company would achieve its profitability target for the year owing to its recent awards and contracts. Therefore, we maintain a Speculative Buy rating on the stock.
Yesterday, Tesco declared its unaudited half year results for the 26 weeks ended 29th August 2015. Group sales declined 1.9% y-o-y to £23.9bn in H1 2015 and the operating profit (before exceptional items) shrunk 54.6% to £354m (H1 2014: £779m). The company’s UK business witnessed a 1.1% decrease in like-for-like (LFL) sales growth; whereas the international segment saw a 1.0% LFL sales increase in the first half. Pre-tax profit narrowed to £158m from £614m in H1 2014 leading to an EPS of 1.13p against 6.11p. Statutory pre-tax profit stood at £74.0m for the period. On the operational front, the company sold its Homeplus business in Korea. Tesco provided customers with more than 500 discounts on key product lines and closed 53 unprofitable stores in 2015. The company replaced the UK defined benefit pension scheme with a defined contribution scheme from November. Tesco added 3,300 suppliers to the Supplier Network and has already trained more than 800 of them. Furthermore, the company took a lot of steps to improve the Tesco business including removal of monthly current account fees and monthly message of foregone interest.
Our view: The first half of 2015 has been disappointing for Tesco as it reported losses due to eroding competitive edge and market share. All of its business segments witnessed a sharp decline led by the UK and ROI (Republic of Ireland) which saw a 69.4% fall in operating profit. The International segment and Tesco Bank reported a 25.5% and 13.1% dip in operating profits, respectively. Tesco is facing tough competition from competitors and the entry of the heavy discounter Aldi and Lidl has considerably changed the industry dynamics and it would take some time for the industry to stabilize at more sustainable levels. However, the company took a lot of steps to strengthen the balance sheet. The sale of its Korean business would result in £4.2bn reduction in total indebtedness and expects £400m annual cost savings from its restructuring investment. Furthermore, the company plans to reduce capital expenditures, manage pension deficit and work towards brand rebuilding. Tesco has a strong historical record in the industry and thus we would like to wait and assess the impact of the measures taken on Tesco’s profitability. For the time being, we retain a Hold rating on the stock.
Yesterday, Diageo informed that it has sold its interest in Desnoes & Geddes (D&G) and Guinness Anchor Berhad (GAB) to Heineken and also acquired additional shares in Guinness Ghana Breweries Limited (GGBL). The company sold its 57.87% stake in D&G and 49.99% stake in GAB to Heineken. Further, Diageo acquired Heineken’s 20% stake in GGBL, increasing its stake to 72.4%. The net cash consideration receivable by Diageo is US$780.5m.
Our view: The aforementioned sale of interest by Diageo is in line with its strategy to enhance focus on the core markets. The deal would result in an exceptional pre-tax profit on disposal of around US$440m. The company plans to use the cash to reduce its borrowings. Furthermore, an increased stake in GGBL would provide Diageo an easy access to the African market and sell its signature brands like Johnnie Walker whisky. Further, the company remains cautious in the emerging markets as weaker currencies would hamper its margins. Diageo is undertaking focused brand building initiatives which include innovative marketing techniques and improving distribution platform. The company has implemented several cost saving and pricing measures to boost earnings and continues to make efforts to expand into new markets. Recently, Diageo reported strong performance for 2015 with improved free cash flow and a 9% increase in the final dividend to enhance shareholder wealth. In view of the overall developments surrounding Diageo, we maintain a Buy rating on the stock.
Sports Direct International (LON:SPD) – Hold
Yesterday, Sports Direct International (Sports Direct) informed that it has entered into a sale and purchase agreement with Sandra Minor (a minority shareholder in Warrnambool) to purchase shares in Warrnambool. Furthermore, the company has also entered into a conditional put and call option agreement with Mark Heaton, Hugh Heaton, John O’Neill, Warrnambool and Katipo Limited in relation to the remaining shares of Warrnambool. The total cash consideration payable by the company for both the agreements is €47.5m, subject to approval from the Irish Competition and Consumer Protection Commission. Post the completion of purchase agreement, the company will have a 50% stake in Warrnambool.
Our view: The aforementioned agreements showcase Sport Direct’s continuous efforts to expand into new markets. Warrnambool is a retailer in Ireland and Northern Ireland that sells sportswear and clothing. The deal provides the company an easy entry to these markets with a conditional option to increase its market share. However, as per the recently released trading update, the company showed no major improvement in its performance. Sports Direct is currently facing tough competition from online retailers and distributors. Going forward, the company plans to improve its product range and availability, optimize its stores and web offerings, and introduce further enhancements to its store portfolio. We would like to wait and watch company’s progress in terms of its expansion and improvement in online services, and maintain a Hold for now.
Economic News
Germany industrial production
Industrial production in Germany fell 1.2% m-o-m on a seasonally adjusted basis in August, after a revised gain of 1.2% in July, the Federal Ministry of Economics and Technology said yesterday. Economists, on the contrary, had expected production to grow 0.2% for the month. On a y-o-y basis, industrial production increased 2.3% in August, following a 0.8% increase in July, behind the market expected rise of 3.3%.
UK industrial production
UK industrial production expanded 1.0% m-o-m in August, compared to a 0.3% dip in July, the Office for National Statistics reported yesterday. The July data was marginally revised upward from the 0.4% decline reported earlier. Markets were expecting a 0.3% rise. On a y-o-y basis, industrial production improved 1.9% in August, from 0.7% in July, better than the market expected gain of 1.2%.
UK manufacturing production
The Office for National Statistics reported that the UK manufacturing output rose 0.5% m-o-m in August, after a 0.7% drop in July. This was better than the market expected increase of 0.3%. On a y-o-y basis, manufacturing output fell 0.8% in August, after a 1.2% dip in July.
US MBA mortgage applications
US mortgage applications surged 25.5% in the week ended 2nd October, after a 6.7% fall in the previous week, the Mortgage Bankers’ Association said yesterday. Refinance index jumped 24.0%, and the gauge of loan requests for home purchases rose 27.0% over the week.