Cube Midcap Report (17 Oct 2019) – Brexit beckons #ULVR #RTO #GFTU #MONY
A busy day in mid-caps (and big-caps) today.
Some RNS announcements I’ve noticed:
- Unilever (ULVR) – 3rd quarter trading statement
- Rentokil Initial (RTO) – 3rd quarter trading update
- Grafton (GFTU) – trading update
- Moneysupermarket.com (MONY) – trading update
- WH Smith (SMWH) – results and proposed acquisition
- Domino’s Pizza (DOM) – Q3 trading statement
Obligatory Brexit comment
I am personally very pleased with the news of a proposed deal between the UK and the EU on Brexit.
The reason for this is that it means continued strength for the Pound sterling, which I have repeatedly argued is undervalued.
Here’s a 1-year EURGBP chart from xe.com:
Admittedly I am talking my own book, but I think the Pound could strengthen lots more from here.
In June 2016, just prior to the Brexit vote, the Euro was only worth about 76p.
If you scroll back a year prior to that, when few people thought that Brexit was likely, the Euro was only worth 71p.
Since then, the uncertainty over Britain’s trade relations and economic growth outside the EU has escalated in a manner that feels relentless.
This might finally be about to end. I haven’t studied Boris’ deal yet and can’t comment on its political merits, but I know that financial markets crave certainty and I strongly believe that the UK is set to receive a huge investment inflow if the Brexit process reaches some sort of conclusion.
If the Brexit process concludes and the UK economy turns out to be in reasonable shape, then I don’t see any stopping the Pound. The ECB is in turmoil over continued extreme easy money policies, including a cut in bank deposit rates to minus 0.5% and €20 billion in monthly government bond purchases.
While the Bank of England has also shown a strong appetite for currency debasement, it does at least have bank rate at (positive) 0.75%. From the point of view of the exchange rate and strengthening the Pound, the BOE merely needs to be less extreme than the ECB. This should not prove to be very difficult.
The Federal Reserve is a more difficult rival and US dollar might prove a tougher nut to crack. But I do expect the Pound to reverse the course of the long-term trend against the Euro.
- Share price: 4666.5p (+1.3%)
- Market cap: £122.2 billion
Some decent headline numbers from Unilever today.
Underlying sales growth
Q3 underlying sales growth is 2.9% (it did better last year, producing underlying sales growth of 3.8%).
Year-to-date growth is still good at 3.4% (at this stage last year, it was running at 3.1%).
The components of Q3 growth are split evenly between 1.4% to volume and 1.5% to price.
Consumer price inflation is still low in many of the largest economies, despite some instances of hyperinflation, so the contribution from price sounds about right. On top of that, the contribution from volume signals stable demand.
Volume growth is tilted towards emerging markets, as you would expect. EM volume growth is 2.2%.
GAAP sales growth
On a total basis for the purposes of financial reporting, Q3 turnover is up an impressive 5.8%. But this includes 2.3% in benefits from currency movements and 0.8% from acquisitions. Strip them out, and you get something much closer to the underlying growth rate.
CEO Alan Jope confirms that emerging markets and Home Care were the key growth drivers, and expectations are roughly unchanged:
For the full year, we continue to expect underlying sales growth to be in the lower half of our multi-year 3-5% range, an improvement in underlying operating margin that keeps us on track for the 2020 target and another year of strong free cash flow.”
Performance by Division
As you can see below, the big performer was indeed Home Care, where volume growth was 3.2%. I note that volumes in Foods & Refreshment came in marginally lower.
For your reference, the Unilever Home Care brands include Cif/Jif, Domestos, Surf and Persil. Hand dishwashing products were “a key driver” in the momentum this quarter.
Food & Refreshment brands include Cornetto, Magnum, Knorr and Lipton.
The large Beauty and Personal Care division did ok. Unilever reports “modest growth” in categories such as skin cleansing, but “competitive intensity” in hair care.
Geographical review – underlying sales growth of 5.6% in Asia / Africa-Middle East / Russia-Ukraine-Belarus looks to be the key growth number here. The equivalent number for Europe saw a decline of 0.3%.
My view – this is a landmark company and a cornerstone of many FTSE-100 portfolios. I aspire to own shares in it some day, perhaps for just a small percentage of my portfolio. The current valuation (forward P/E 19.4x, EV/EBITDA 11.5x) and immediate prospects don’t particularly stand out to me. But for those who like to sleep well at night, it’s difficult to argue against this one.
Rentokil Initial (RTO)
- Share price: 450p (+2%)
- Market cap: £8.3 billion
Much more impressive growth rates posted from Rentokil today: the key number to look at, in my view, is the 9.8% growth in “ongoing” revenue, at constant exchange rates, of which 5.5% was organic.
(“Ongoing” revenue is “the performance of the continuing operations of the Group (including acquisitions) after removing the effect of disposed or closed businesses“)
Rentokil is the well-known pest control business, also providing hygiene services, workwear and interior landscaping through its subsidiaries.
Looking through the divisional performances, there’s not much to choose between them when it comes to organic growth. They are each growing between 4.5% – 6%.
Acquisitions – 32 business have been acquired year-to-date, “primarily in emerging and growth markets”. The 32 businesses have annualised trailing revenues of c. £70 million, which is less than 3% of RTO’s 2018 revenues. Not a big deal, then.
I am pleased with our Q3 results and our Group Organic Growth of 5.5% is our highest level of quarterly Organic Growth in over a decade. Pest Control has performed well, growing organically by 5.9%, and Hygiene has demonstrated further momentum, growing organically by 4.8%. Our performance in Q3, combined with further progress in our value-creating M&A programme, means we remain on track to meet expectations for the full year.
My view – it’s hard not to like this company, but it’s also something of a challenge to understand the valuation at a forward P/E multiple almost 30x.
One way of looking at might be that this is the difference between organic sales growth of 5.5% and organic sales growth of just 2.9% (Unilever).
RTO’s earnings per share is forecast to rise by between 10% and 11% each year, reaching 17.6p by 2021. At that level, the P/E multiple versus the current share price falls to around 25.5x.
I could be convinced by further study demonstrating an impenetrable competitive position, but for now I don’t see attractions at this valuation.
Grafton Group (GFTU)
- Share price: 781p (-10%)
- Market cap: £1,857 million
Bad news for shareholders in this large group of builders merchants.
An update had been scheduled for 12 November, but it was brought forward to inform shareholders of a “softening in activity”.
This has occurred only since the latter stages of Q3 (i.e. from September):
Like-for-like Group revenue in continuing operations increased by 0.9 per cent and total revenue by 4.5 per cent for the three months to 30 September 2019. Following an encouraging start, trading towards the end of the quarter and more recently has been impacted by a softening in activity.
- weak underlying demand fundementals from UK households due to economic uncertainty (despite my Brexit comments above, it is true that the UK is currently at risk of recession).
- Irish consumer sentiment suffering from “a more cautious international outlook”.
- Netherlands – demand affected by court ruling on nitrogen emissions, delaying permits for new construction permits (surely this will be a temporary problem?)
On a 9-month view, like-for-like Group revenue is up by 3.1% this year.
Profit warning: “Against the backdrop of softer third quarter trends which have continued into October, the Group currently expects to report full year operating profit for continuing operations in the range of 4-8 per cent lower than current consensus1. ”
The company helpfully provides the previous consensus forecast for adjusted operating profit from continuing operations, which was £193.5 million (pre-IFRS 16).
My view – I tend to shy away from distributors and from the construction industry. These aren’t sectors where I typically invest.
Thinking it through, I suspect that the run-rate of profitability here must be significantly lower now, compared to consensus. Operating profit will miss by 4-8%, but the weakness which triggered this profit warning only began in late Q3. So I wonder if today’s 10% discount in the share price is enough?
- Share price: 356p (-8%)
- Market cap: £1,909 million
This one is of particular interest to me, since I own shares in smaller rival Goco (GOCO).
Shares in MONY have fallen 8%, despite the Board stating in today’s update that they “remain confident of meeting current market expectations for the full year“.
Company-compiled consensus expectations are for adjusted EBITDA of £141.9 million, using the average of analyst estimates.
That might translate to net income in the region of £98 million, using consensus forecasts visible to me.
So why the disapppointment today? This sentence in the update is to blame:
- Money underperformed due to the continuing challenges in product availability
Money is responsible for about 20% of the group’s revenues (versus 50% from Insurance).
Revenue from Money grew by 3% in 2018, to £88 million. Credit offerings did well, but Current Accounts contracted.
In H1 of this year, Money increased by a further 5% but this included a 1% decline in Q2.
At the time, the company described the issues like this:
Revenue in our Money business grew 5% with robust performance in credit, supported by customer experience optimisation and conversion improvements. The reduction in availability and attractiveness of promotional products diminished switching as we progressed through the half.
Today, the company reports that revenue from the Money segment declined by 5% in Q3. Things are clearly getting worse.
Does this reflect less competition among credit card and current account providers? Could this in turn be a reflection of underlying weakness in the economy?
My view: I am inclined to think that this is an economic problem, rather than a company-specific problem, but I’ll keep an open mind on this point.
I continue to have a positive impression of Moneysupermarket, and will maintain a watching brief.
All done for today. Thank you so much for dropping by!
I’ll be back again tomorrow with more midcap news.