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Beaufort Securities Breakfast Alert: ValiRx, British American Tobacco, GKN, Whitbread

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Markets
Europe

The FTSE-100 finished yesterday's session 0.45% higher at 7,017.64, whilst the FTSE AIM All-Share index closed 0.04% better-off at 825.61. In continental Europe, the CAC 40 index ended the day 0.26% lower at 4,541 and the DAX closed 0.04% down at 10,757.
Wall Street
In New York overnight, the Dow Jones fell 0.3% to 18,169.27, the S&P-500 lost 0.38% to finish at 2,143.16 and the Nasdaq shed 0.5% at 5,283.40.
Asia
In Asian markets this morning, the Nikkei 225 had risen 0.04% to 17,371.43, while the Hang Seng lost 0.69% to 23,403.5.
Oil
In early trade today, WTI crude was down 1.32% to $49.30/bbl and Brent was down 1.16% to $50.20.

Headlines
Lloyds sets aside extra £1bn for PPI

Lloyds Banking Group has set aside a further £1bn to pay compensation for mis-sold payment protection insurance (PPI). The extra provision was expected after the deadline for PPI claims was extended to June 2019. The announcement came as the bank announced that pre-tax profits for the three months to the end of September fell 15% to £811m. Underlying profits for the quarter were down by 3% to £1.92bn. Lloyds is 9%-owned by the taxpayer.

Company news

ValiRx (LON:VAL, 7.20p) - Speculative Buy
ValiRx, the quoted life science company which focuses on clinical stage cancer therapeutic development, taking proprietary & novel technology for precision medicines towards commercialisation and partnering, yesterday announced an update on its patents for the clinical stage therapeutic compounds VAL201 and VAL401, which are currently in Phase I/II and Phase IIB clinical trials to treat prostate and lung cancer respectively. Most significantly, it confirmed receipt of patent approval by the Japanese Patent Office for VAL201. This grant means that ValiRx now has patent protection in Japan, Europe and Australia and USA, with further patents pending in significant markets across the rest of the world, alongside other granted and patents pending for its therapeutic technologies world-wide. Management also announced that ValiSeek Limited, the joint venture between ValiRx and Tangent Reprofiling Limited, had received notification that a third US patent has been allowed by the US Patent Office covering the use of VAL401 in the treatment of pancreatic adenocarcinoma.

Our view: The granting of these latest patents further extend the Group's global geographic patent coverage. VAL201’s news builds on the molecule’s early clinical trial success, while the specific use indication added coverage in the US represents a further endorsement of the technology and science lying behind VAL401 while also strengthening the portfolio at an important time in its development pathway. Indeed, ValiRx is now moving through a number of important clinical developmental milestones and potential value inflection points as far as its VAL201, 301 and 401 pipeline is concerned. For all such cash-consuming pharmaceutical development projects source of, and continued access to, funding remains management’s most significant, ongoing headache. The placing that was completed in September with existing and new investors, however, successfully raised £1.2 million which, in addition to the Convertible Loan Facility set up with Yorkville to provide up to US$3.75 million in potential 3 tranches, is expected to provide the resource necessary to reach identified goals and deliver tangible value-added for shareholders. One such point is likely to appear in the form of VAL401’s early safety and tolerability indications that are expected to be available before the end of 2016. In anticipation of this and further progress elsewhere, Beaufort retains its Speculative Buy recommendation on ValiRx.

Beaufort Securities acts as corporate broker to ValiRx

Brtish American Tobacco (LON:BATS, 4,716.04p) - Buy
BATS, which owns 42.2% of Reynolds American Inc. (Reynolds), has made a proposal to merge with Reynolds through the acquisition of the remaining 57.8% in the company. US securities laws require BAT to announce its merger proposal promptly after it was made to the Board of Reynolds. As a result, BAT has been unable to have prior negotiations with Reynolds regarding the proposal.

BAT's proposal to merge with Reynolds:
Values Reynolds at US$56.50 per share, of which US$24.13 would be in cash and US$32.37 would be in BAT shares.
Represents a premium of 20% over the closing price of Reynolds common stock on 20 October 2016.
This would create a stronger, truly global tobacco and Next Generation Products (NGP) company with:
A leading position in the US tobacco market, the largest global profit pool (ex-China) with strong growth dynamics.
A significant presence in high growth emerging markets across South America, Africa, the Middle East and Asia, together with the most attractive developed markets.
A unique portfolio of strong brands, bringing together ownership of Newport, Kent and Pall Mall.
Combined Next Generation Products and R&D capabilities to deliver a world class pipeline of vapour and tobacco heating products across all the fastest growing NGP markets globally.
Creating the world's largest listed tobacco company by net turnover and operating profit.
The Company says there is a strong financial rationale for the transaction that supports long-term delivery for all stakeholders. The Company say this is a premium offer, supported by modest cost synergies, with a significant share consideration enabling participation in the long-term benefits. The Company also say it is earnings accretive in the first full year and it is expected to be accretive to dividends per share. The combined company would maintain a strong financial profile, with a target of maintaining a solid investment grade credit rating and enhanced cash generation. The total consideration for the remaining 57.8% of Reynolds would be US$47 billion, of which approximately US$20 billion would be in cash and US$27 billion in BAT shares. The Proposal represents a premium of 20% over the closing price of Reynolds common stock on 20 October 2016 and an Enterprise Value of US$93 billion which, based on reported LTM EBITDA to 30 September 2016 represents a multiple of 16.3x. The proposed merger is subject to endorsement of Reynolds's independent directors (not designated by BAT) and approval by BAT and Reynolds shareholders. BAT's Chief Executive, Nicandro Durante commented: "We have been a shareholder in Reynolds since its creation in 2004 and have benefited from its growth in the US market. The acquisition of Lorillard in 2015 has further strengthened Reynolds's business. The proposed merger of our two great companies is the logical progression in our relationship and offers all shareholders a stake in a stronger, truly global tobacco and Next Generation Products company. BAT is proud of its track record of consistent delivery for shareholders and this transaction would further strengthen that delivery in the future."

Our view: The combined Group would be the world's largest listed tobacco and Next Generation Products business by net turnover and operating profit with exposure to both cash generative developed and high growth developing markets, giving a unique capacity to exploit industry opportunities as they develop. The cost synergies associated with the proposed merger are estimated by BAT to be relatively modest at around US$400 million, however this would need to be verified following engagement with Reynolds. Under the long-standing Governance Agreement between Reynolds and BAT, the proposed merger must be approved by the independent directors of Reynolds not designated by BAT (the Other Directors). BAT will not pursue its proposal without this endorsement. The proposal is also subject to the completion of limited confirmatory due diligence and the negotiation and execution of definitive transaction documents mutually acceptable to and approved by the Boards of BAT and Reynolds. The consummation of any merger would further be subject to regulatory approvals and shareholder approvals, including the approval by a majority of the votes cast on the proposed merger by holders of the Reynolds shares not owned by BAT or its subsidiaries and approval by BAT's shareholders, and other customary conditions. The proposed merger would not be subject to any financing conditions. BAT's existing manufacturing footprint would be enhanced by the inclusion of Reynolds's high quality production facility in Tobaccoville, North Carolina. We retain our BUY recommendation.

GKN (LON:GKN, 314.32p) - Buy
GKN has issued a trading update for the nine months ended 30 September 2016; management sales increased 21%, including organic sales growth of 2%, in line with expectations. Sales in the Automotive businesses continue to perform well against the market and the Aerospace division grew in line with its expectations. Land Systems’ markets remain tough.

Our view: GKN has continued to make progress. Organic growth was 2%, whilst the Company also benefitted significantly from the successful acquisition and integration of GKN Aerospace Fokker as well as from favourable currency translation due to the weakness of Sterling. As expected, the organic profit performance was down primarily due to one-off items, including the costs of the restructuring, which will position GKN better for the years ahead. In line with the global economic outlook, the Company see growth rates easing in its major markets. The automotive market is now forecast to see a 1% increase in light vehicle production in the final quarter. New commercial aerospace programmes continue to ramp-up, although at a slower rate than expected. The military aerospace programmes and agricultural equipment markets look set to continue their decline. Despite the slightly tougher macro-economic environment, the Group continues to expect 2016 to be another year of growth. Good progress in Q3 but predicting tougher times ahead. We retain our Buy recommendation despite the cautious outlook.

Whitbread (LON:WTB, 3,708.15p) - Buy
Whitbread, the owner of the Premier Inn, Costa Coffee and varieties of restaurant chain, yesterday announced its interim results ended 1 September 2016 (‘H1 FY2016’). During the period, total revenue advanced by +8.1% to £1,555.9m while like-for-like (‘LFL’) sales grew +1.9%, against the comparable period (H1 FY2015). Premier Inn and Costa had total sales growth of +8.9% and +10.7% with LFL sales up +2.4% and +2.3%, respectively. Restaurants delivered total sales growth of +1.5% with LFL sales up +0.3%. Pre-tax profit increased by +3.4% to £263.6m pushed slightly down by some exceptional costs primarily relating to the Premier Inn international’s withdrawal from India and South East Asia. The resulted basin earnings per share improved by +2.2% to 111.42p. Group return on capital stood at 15.1%, while cash flow from operations improved to £431.4m and net debt reduced to £988.2m (end-FY2015: £909.8m). On the operational front, the Group opened 6 new Premier Inn hotels and 124 net cost stores worldwide during the period. Whitbread’s CEO, Alison Brittain commented “In our hotels business, we are expanding the network of our new 'hub by Premier Inn' city centre hotels and making progress in consolidating and rejuvenating our restaurant brands. In Costa we are trialling new 'finer' coffee concepts, introducing a new fresher food range and making good progress rolling out our Costa Pronto and Drive Thru formats. Whilst it is early in the second half and there is uncertainty in the UK's economic outlook, we expect to deliver in line with full year expectations.” The Group declared interim dividend of 29.90 (H1 FY2015: 28.50p) to be paid on 16 December 2016.

Our view: Whitbread performed quite resiliently during the H1 FY2016, delivering revenues in line with expectations and underlying pre-tax profit (£307m) marginally ahead of the consensus analysts’ estimates. The Group enjoyed positive LFL sales growth across its three businesses. Looking ahead, the Group said it will deliver full year result in line with current market guesses. Operationally, things remain on plan: Whitbread in on course to open 230-250 Costa stores worldwide and install c.1,250 Costa Express machines. Premier Inn, on the other hand, is now expect to open c.3,700 new UK rooms for the full year revised down from the previously guided c.4,000-4,500 rooms. The Group has reaffirmed a committed net pipeline of c.14,000 rooms and milestone for c.85,000 Premier Inn UK rooms. UK’s hotel industry has seen a rising price in September according to ONS as weaker Sterling has boosted the tourism industry. Despite this, total revenue per available room for Premier Inn in UK has underperformed the total UK market. Management of the rival InterContinental Hotels Group recently said in its conference call that branded hotels performed slower than the individual hotels and said overall supply of rooms in the UK is continue to grow in 2017. Having said this, the LFL sales growth of the existing Premier Inn grew nicely at +2.4% in the first half as its extension programme worked well. For Costa, the Group is expected to open 28 stores in the H2 (H1 FY2016: 14 stores) seeking to seize the future opportunity. The consensus analysts’ estimate currently indicates FY2016E and FY2017E P/E of 15.2x and 14.1x with dividend yield of 2.6% and 2.8% respectively. After reacting negatively yesterday as investors reflected on a rather tough trading in London and a slowing pipeline, Beaufort retains its Buy rating on the shares given that full year estimates remain unchanged and place the shares on just 15.6x full year 2017 earnings.

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