Cube UK Report (29 April 2021) – Picking up where we left off?

Cube UK Report (29 April 2021) – Picking up where we left off?

Good morning, it’s Roland here with today’s report.

There’s been a deluge of trading update this morning — far too much for me to cover. One theme at the moment seems to be the market view that we will pick up where we left off, post pandemic. I mentioned this on Tuesday in relation to the valuation of popular leisure stocks.

This week we’ve seen Lloyds, Unilever (I hold) and Shell (I hold) beat expectations with their Q1 figures. This morning, kitchen firm Howden said that sales for the 16 weeks to 17 April had been 13.1% ahead of 2019.

Are we seeing vaccine-induced euphoria, or is a quick return to normal a real possibility?

On the one hand, the rapid roll out of vaccinations in many developed markets seems to promise a direct route back to normality, at least domestically. But on the other hand, government support measures are still playing an active role in preventing job losses and bankruptcies. What will happen when these are withdrawn?

I don’t know the answers to these questions. But as a natural contrarian I have a slight feeling of discomfort at such a cheery consensus. However, the numbers seem to be proving me wrong — at least, so far.

Rather than cover any of the FTSE 100 heavyweights today, I’ve decided to look at two FTSE 250 stocks I rate quite highly and might own at the right price:

  • Meggitt
  • Inchcape

Meggitt

  • Stock data should display here.
Market cap £3.6bn
RNS Q1 trading update
Writer disclosure No position

As an aerospace business, Meggitt was hit hard by last year’s aviation shutdown. But in my view things were never quite as bad as they might have seemed, for several reasons.

  • Meggitt’s balance sheet was strong enough (with the help of a non-core disposal) to avoid any messy and dilutive refinancing.
  • The group’s defence business remained resilient. Revenue in this division fell by just 7% in 2020. 80% of military fighter jet programmes use Meggitt’s wheel and brake systems.
  • Finally — and perhaps most important — around 70% of Meggitt’s revenue comes from products where it is the sole supplier to the market and owns the intellectual property. The company says that 73,000 civil aircraft use its products — market share is high.

Since it was clear (in my view) that passenger aircraft would start to fly again at some point, all Meggitt had to do was to wait out the storm, while maintaining product availability and development.

That’s pretty much what happened, and the company remained profitable on an underlying basis in 2020.

However, today’s first-quarter update makes it clear that the pace of the recovery remains mixed and somewhat uncertain.

  • Cargo, private jet and domestic flying markets (especially China & US) are performing relatively well. Business jet activity is now said to be just 10% below 2019 levels, with activity still growing.
  • International flying remains “weak”. Global ASKs (available seat kilometres) were down by 59% in January and by 63% in February, compared with 2019 levels.

No real surprises there. But the company now thinks that the “pace and extent of recovery” during the second half of the year is likely to be softer than previously expected.

What does this mean in financial terms? Meggitt says that group revenue was down by 29% during the first quarter, compared to the same period in 2020. The segmental split confirms the trends we saw last year:

  • Civil aerospace: -46%
  • Defence: -10% (vs a strong comparative)
  • Energy: -7%

Full-year guidance is for revenue in line with 2020, with underlying operating profit improved. Importantly, free cash flow is expected to be positive.

My view

Meggitt’s focus on sole-supplier products where it owns the IP provides the group with a durable competitive advantage, in my view. It has a sizeable market share in its key aerospace markets, providing a second key advantage.

These advantages have been reflected in solid profitability. Operating margin in a normal year is in the mid-teens and free cash flow has historically been strong. One downside is that it’s a somewhat capital-intensive business, so returns on capital employed are relatively modest — the 10-year average is about 7%.

The shares have rebounded strongly since November but remain around 30% below pre-pandemic levels. Changes made to the business in recent years have tightened the firm’s focus on newer civil aircraft and sole-supplier products. I think this should bode well for medium-term growth and improved profitability.

Although the 2022 forecast P/E of 17 is not obviously cheap, I think Meggitt could still be reasonably priced on a medium-term view.


Inchcape

  • Stock data should display here.
Market cap £3.1bn
RNS Q1 trading update
Writer disclosure No position

Inchcape’s main business is as a global automotive distributor. The company essentially sits between manufacturers and dealers, taking care of logistics, in-country localisation and overseeing dealer networks. Major markets include Asia, Australasia, Europe, the Americas and Africa — this is a near-global business.

Although Inchcape also has a car retail business, this is smaller in size and has been shrinking in recent years. It’s limited to the UK and some European markets.

First-quarter performance was ahead of expectations, according to the firm. Revenue performance certainly seems relatively strong to me, given the showroom closures in some markets:

  • Group revenue: -3%
  • Distribution revenue: +10%
  • Retail revenue: -18%

Inchcape continued to expand its distribution footprint during the quarter, with new deals with JLR in Indonesia and Daimler in Guatemala. Its Russian retail-only business is being scaled back, which should improve future profitability.

Indeed, CEO Duncan Tait says he expects “material growth in profits and an improved operating margin for FY21”.

My view

For me, Inchcape is a more attractive business to hold long-term than a UK-focused automotive retailer. INCH is exposed to faster-growing emerging markets and is more profitable than most UK dealership groups, with a 10-year average ROCE of 15%.

This doesn’t mean that Inchcape isn’t exposed to economic cycles. The company’s dividend history shows cuts in 2000, 2008 and again last year.

Inchcape’s share price has doubled from last year’s low of 400p to around 800p today. That’s a level last seen in 2018. This prices the stock on 19 times 2021 forecast earnings, falling to a P/E of 15 in 2022.

I’m not sure I’m optimistic enough to buy the shares at this level, but I accept this could prove short-sighted. If predictions of a ‘roaring twenties’ of economic growth (followed by bust?) come true, then this business could have some good years ahead.

I continue to like Inchcape. But as with many other consumer-facing stocks at the moment, I think a lot of good news is already in the price.


That’s all for today, thanks for reading. Please let me know what you think below with a thumbs up (or down!).

I should be back with you next week. Until then, I hope you enjoy the bank holiday weekend.

Roland

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