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Broker tips: G4S, GBG, Rotork
Kepler Cheuvreux initiated coverage of G4S with a 'buy' rating and 310p price target as it said that new management's "less is more" strategy is about to deliver a significant boost to the group's profitability while putting the security company on a steadier growth path.
Kepler pointed out that for the last four years, management has been busy addressing past issues. It has focused on repairing its balance sheet, selling non-core assets, discontinuing onerous contracts and introducing new internal processes to promote operational excellence and provide more innovative security and cash handling solutions for its clients.
"Although this has made G4S's investment case hard to follow, we believe payback time is rapidly approaching. Now, the company is poised to benefit from a series of self-help refinancing and cost-saving catalysts, while its portfolio has been pruned to the core, just as the group is about to return to a more reliable 4-6% organic growth path."
It said the strategy has made G4S a slower but safer investment, while its new focus on operational excellence and innovative security/cash handling solutions may lead to margin progress by 2020.
With costs under control, Kepler estimated that the margin should improve by 10-20 basis points a year, while soon the cash flow should benefit from the end of the Compass contract.
In addition, it noted that G4S is trimming its central costs and rolling out its Javelin human resources management platform worldwide. At stake are at least £70-80m worth of cost savings by 2020E and greater control of the margin.
With GBG's emphasis switching from income to capital growth, analysts at Canaccord Genuity lowered their target price on the internationally focused insurance and benefits provider on Monday.
However, Canaccord reiterated its 'buy' rating on GBG despite its "shaky start to life" since listing on AIM back in February last year, acknowledging that, while management does need to recover the market's trust, it did not believe the group's underlying growth or risk appetite had "materially changed".
GBG is a provider of international benefits, the self-proclaimed largest integrated provider in the world, serving expatriates, third-country nationals, locals and companies with health and travel insurance, life insurance, income replacement and special risk protection.
Despite hits to GBG's capital coming in the form of a $12.3m provision against Angolan receivables, which reduced its tangible net asset values by a third, a fraction less than its stock has lost since warning investors that its operations in the African nation would weigh on profits back on 19 March, Canaccord still felt the insurer showed a sufficient buffer to regulatory requirements.
On the other hand, Canaccord pointed out that GBG's board had "shown caution" on dividend commitments, prioritising improvement in capital strength, something the broker viewed as primarily being a defensive measure to mitigate risk to its credit rating.
The removal of Angola's contribution was seen as likely to act as an earnings headwind throughout 2018, however, from 2019 onwards Canaccord expect GBG to return to "high-teens earnings growth".
Discussing GBG's "attractive valuation", Canaccord reduced its 12-month forward target price to 155p from 200p, primarily reflecting the Angola provision.
Credit Suisse downgraded actuator manufacturer and flow control company Rotork to 'underperform' from 'neutral' on valuation grounds.
The bank, which left its 300p price target unchanged, pointed out that the stock is now close to pricing in its blue sky valuation, in which Rotork grows organically at 10% in 2019/20.
"In terms of fundamentals, we see risk that 2018 margins underwhelm and judging by the +10% share price reaction on the Q118 IMS the management comments around unfavourable divisional mix in orders' and 'investing much of the profit contribution' appear to have been largely ignored.
"A comparison versus consensus is difficult currently as many have not updated since the Q118 IMS (we are now 6% ahead on EBIT this year) but we would focus more on what is priced in with the free cash flow yield now having fallen to 3.5% in 2019E versus the sector average of 5.3%."
CS said margin expansion may be back-end loaded. It noted that Rotork is aiming for a return to 25% EBITA margins in the mid-term, but pointed out that it's currently in investment phase with a £15m impact this year.
"We would expect a return to more normal operational leverage (40%) in 2019 but the sharper step-up in margins to come in the latter parts of the 3-5 year programme (i.e. 2020 onwards). We also see limited room for error in the current valuation if divisional mix and higher than planned investments resulted in 2018E margins being flat (versus our 70 basis points margin expansion) which is a risk."