Cube Midcap Report (31 Oct 2019) – 888 rejoins big league #888 #LLOY #SN

Cube Midcap Report (31 Oct 2019) – 888 rejoins big league #888 #LLOY #SN

Good morning!

Quite a few things for us to look at today.

This report covers:

This is not a comprehensive list of updates: we also had updates from Hilton Food Group (HFG), Future (FUTR), Elementis (ELM), Crest Nicholson (CRST), PPHE Hotel (PPH), BT Group and Derwent London (DLN).

888 (888)

  • Share price: 175.25p (+2%)
  • Market cap: £645 million

Changes in FTSE UK Index Series

(Please note that I have a long position in 888.)

Shares in 888 were up 5% at one point this morning, but they have now calmed down.

I’ve been invested here since December 2018, and written about it on this website on numerous occasions, most recently in September.

Last week, it was announced that 888 had won Casino Operator of the Year from EGR (eGaming Review).

It’s easy (and usually correct) to be cynical about industry awards. But for what it’s worth, 888 thinks that this “prestigious” award, which followed “a tough judging process, including a presentation to a panel of industry experts”, reflects the progress it has made in developing its products:

At the Capital Markets Day in June this year, the Group highlighted the impact of Orbit, its new user-friendly casino platform with an AI-powered dashboard, and its industry-leading portfolio of high quality games developed from its in-house studio, as well as from the best third party gaming providers. These initiatives have led to a significant increase in all casino KPIs for the Group.

The Casino segment is responsible for two-thirds of 888’s revenues, so the success of this platform really is of great importance to investors.

Also of importance to investors is the announcement, made after the market closed last night, that 888 would be re-joining the FTSE 250 Index.

One in, One out

Last October, I spotted the value in Merlin Entertainments (MERL), but sadly failed to act on it – the returns on capital from that property-heavy theme park and hotel operator were not enough to entice me to purchase.

Blackstone and Lego want it, and are getting it for 455p.

With Merlin leaving the FTSE-250 Index, that opens a space for someone new. 888 is that someone.

As experienced investors will know, index changes can provide some nice trading opportunities. Index funds and policy-constrained institutions may start buying or selling certain shares, depending on these changes. Traders who predict these changes can move in advance, predicting the increased supply or demand.

The shares which currently have the lowest market cap in the FTSE 250, and are therefore at risk of relegation, are as follows (I will leave out trusts except for REITs):

  • Card Factory (CARD)
  • IP Group (IPO)
  • Bank of Georgia (BGEO)
  • Newriver REIT (NRR)
  • Barr A.G. (BAG)

Of these companies, the one that I would be most interested to purchase is Barr (BAG). Perhaps the threat of relegation from the midcap index is helping to suppress demand for its shares?

On the flip side, the companies in the FTSE Small Cap Index with the highest market cap are as follows (again leaving out trusts except for REITs). They could (ceteris paribus) enjoy a higher valuation, if they do indeed get promoted:

  • Gamesys (GYS)
  • 888 (888) (we know this one is getting promoted, so I’ll add another share to this list)
  • Biffa (BIFF)
  • Just Group (JUST)
  • Intu Properties (INTU)

I recall that Intu (INTU) dropped out of the FTSE 250 Index only last month (along with Woodford Patient Capital Trust, Ted Baker and Metro Bank).

Anyway, it’s good news for 888 and I am hopeful that both the company and its shares will continue to perform in a reasonable way for its shareholders.

The forecast P/E ratio is a humble 15x and I believe that the quality of the company is not to be sniffed at, for this price. Return on capital, as calculated by Stockopedia for example, is 37%.

The main factors which might keep investors away, in my opinion, are the permanent regulatory threats to the gambling industry, along with 888’s incorporation in Gibraltar and non-UK (Israeli) control. As investors, we all have to place our bets and take our chances!


Lloyds Banking Group (LLOY)

  • Share price: 56.635p (-2%)
  • Market cap: £39.7 billion

Q3 2019 Interim Management Statement

This is my third coverage of a bank this week!

Additionally, Roland covered RBS (in which he holds shares) last week. Like RBS, Lloyds has been on the receiving end of many PPI (payment protection insurance) information requests.

The final deadline for consumers to complain about being mis-sold PPI was in August, so the issue is finally drawing to a close. This means that we can look forward to a new era for banks in which PPI compensation is no longer a drag on results – at least until the next popular complaint!

CEO comment: In summary, António Horta-Osório says that the company made progress despite “a challenging external environment”. There was a “significant” impact from PPI, driven by an “unprecented” number of information requests as the August deadline loomed.

Financial Highlights
  • Year-to-date (nine-month) pre-tax profit of £2.9 billion, which is after provisioning £2.45 billion for PPI compensation. So the year-to-date pre-tax profit before PPI provisions is £5.35 billion.

Q3 itself was loss-making, because all of the bank’s underlying profits were eaten up by PPI provisions. Without that, pre-tax profit in the quarter would have been in the region of £1.8 billion.

  • CET1 ratio of 13.5% (after taking future dividend payments into account), down from 14% at the end of the prior quarter.

This is the same ratio reported by StanChart (see yesterday’s report).

While bank CEOs (including at Lloyds) often like to mention the strength of their balance sheets, I am currently of the view that bank balance sheets are currently too safe, i.e. they are carrying too much equity and therefore the return on equity (ROE) which they can realistically achieve is too low.

The general equation is that ROE = ROA * leverage. If leverage is low, then ROE is low. And if ROE for the company in general is low, then it’s likely that reinvesting earnings at its low ROE won’t help earnings to grow very quickly. And if earnings aren’t growing very quickly, then the shares aren’t worth all that much. Simples!

On the more positive side, banking net interest margin is 2.89% year-to-date (slightly lower than last year). This is much better than all the other banks we’ve covered.

  • Underlying return on tangible equity is 15.7%, but only 6.8% using the unadjusted numbers.

Since 80% of the adjustments relate to PPI, I’m inclined to think that a fair measurement of ROTE is much closer to the underlying number than the unadjusted number.

Last year, after nine months, the unadjusted ROTE was 13%. Something in this ballpark is a fairer reflection of ex-PPI performance.

Strategic highlights
  • Invested £1.7 billion this year in its Global Strategic Review (“GSR3”).
  • Launched Schroders Personal Wealth.
  • Bought Tesco’s prime residential mortgage portfolio for £3.7 billion
  • Net interest margin of 2.88% (negligible miss vs. 2.9% previous guidance).
  • Operating costs to be <£7.9 billion. This is better than previous guidance of <£8 billion.
  • “Capital build” for the year will be c. 75 basis points, much worse than previous guidance of 170-200 bps.

My view – of all the banks I’ve studied this week, and including RBS, this is the one I’d be most interested in.

The underlying performance (ROTE/net interest margin) are stand-out performers, and the PPI headwind is finally over.

Lloyds trades on a forecast P/E ratio of c. 8x and a price to book value of 0.8x (or 1.07x tangible book value).

If ROTE is in the mid-double digits going forwards, I would expect investors to enjoy solid rewards from current levels. Of course, when discussing banks, it’s mandatory to include the disclaimer that there is lots that can go wrong!

But as an occasional trader of the FTSE-100, I have some confidence that this one can hold its value and help to support the index.

Smith & Nephew (SN.)

  • Share price: £16.49 (-4%)
  • Market cap: £14.4 billion

Trading Statement

Smith+Nephew (LSE:SN, NYSE:SNN), the global medical technology business, announces its trading report for the third quarter ended 28 September 2019.

This company has a fine track record of revenue and profits growth.

Today we learned that it produced underlying revenue growth of 4% in Q3, or actual revenue growth of 6.5% including acqusitions and FX headwinds.

Geographically, it won’t come as a shock that emerging market (EM) growth was higher – in the”mid-teens”, and “led by another quarter of strong growth in China”.


Guidance is raised for underlying revenue growth, from 3% – 4% to 3.5% – 4.5%. It is running at 3.9% year-to-date.

But the trading profit margin is less encouraging: guidance is downgraded to “about 22.8%” (it was previously 22.8%-23.2%).

The reasons given for this downgrade are: “our decision to continue to invest in opportunities to support medium-term growth, dilution from the acquisitions, and a small foreign exchange headwind in the second half of 2019“.

The market doesn’t particularly like this update, but I’m inclined to think that this remains a strong candidate for investors who like to sleep well at night. The forecast P/E multiple of c. 20.5x is about right for this high-quality operation.

DS Smith (SMDS)

  • Share price: 357.6p (~unch.)
  • Market cap: £4,910 million

Pre-close statement

This international packaging business reports consistent trading and as such its expectations are unchanged.

We anticipate good margin progression in the period, consistent with the upgraded target of 10% to 12% return on sales. This reflects strong pricing discipline and cost improvements together with modest box volume growth, as ongoing macro-economic uncertainty continues to impact volumes in some markets, in particular those economies with significant export-led market exposure such as Germany.

This one doesn’t excite me, but it’s another solid performer.

Better late than never!

See you again tomorrow morning for more midcap news.





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