Beaufort Securities Breakfast Alert: CRH, Kier Group, Royal Mail, Watkin Jones


Kier Group (LON:KIE)
Royal Mail (LON:RMG)
Watkin Jones (LON:WJG)

"Fed Chair Janet Yellen yesterday gave her strongest comments to date in favour for a policy tightening in December, telling Congress an increase could be "appropriate relatively soon." She also warned that there would be an eventual price to pay for Donald Trump's 'big government spending', in the form of inflation and a spiralling national debt. The immediate result, however, was for the Dollar to extend its rally during the Asian session, pushing it beyond the Y110 mark for the first time in five months, as yesterday's housing, jobless and inflation data also demonstrated the US to be in its best health for a decade. Another result of this was for the gap between US and German government-bond yields to widen to a 27-year high, as investors placed their bets on Trump's administration sparking an extended phase of expansion, against Europe's political risks, highlighted by Italy's forthcoming Referendum and next years' elections in Germany and France which, some believe, could potentially foster sufficient national tensions to threaten the very existence of the EU. This all blew warm winds over the US equities, with all three principal indices rising once again, as financials and technology stocks celebrated the overnight news. Asia was less convinced, with only Japan putting in a strong performance, sending the Nikkei to a 10-month high in early morning trade as the export-led territory welcomed the weakening Yen. By comparison, the Shanghai Composite closed weaker and other local markets made just fractional movements, as traders considered tomorrow's start of the APEC economic leaders conference in Peru which will discuss cooperation programmes in the Asia Pacific, Trump's proposals for protectionist tariffs and Xi Jinping's vision of the FTAAP following the anticipated collapse of TTIP. Providing no strong direction for London's opening, the FTSE-100 is seen gaining 10 or so points in early trade. There are no significant UK data releases scheduled for today, although a speech by the Bank of England's Ben Broadbent will be studied for any hints regarding of Phillip Hammond's forthcoming Autumn Statement while, later this afternoon the Fed's John Williams may reflect on Janet Yellen's Testimony. UK corporates due to report earnings or trading updates include Electrocomponents (ECM.L), Fuller, Smith & Turner (FSTA.L) and Jimmy Choo (CHOO.L)."
- Barry Gibb, Research Analyst


The FTSE-100 finished yesterday's session 0.67% higher at 6,794.71, whilst the FTSE AIM All-Share index closed 0.20% better-off at 810.93. In continental Europe, the CAC-40 finished 0.59% higher at 4,527.77 whilst the DAX was 0.20% up at 10,685.54.

Wall Street
On Wall Street last night, the Dow Jones added 0.19% to stand at 18,903.82, the S&P-500 ticked-up 0.47% to 2,187.12 and the Nasdaq rose 0.74% to 5,333.97.

In Asian markets this morning, the Nikkei 225 had gained 0.59% to 17,967.41, while the Hang Seng was up 0.08% at 22,280.74.

In early trade today, WTI crude was down 1.03% to $44.95/bbl and Brent was down 0.71% to $46.16/bbl.


MPs call on government to cut air travel tax by 50%

MPs are urging the government to halve air passenger duty in next week's Autumn Statement, saying the tax hampers post-Brexit Britain's ability to trade outside Europe. The British Infrastructure Group (BIG) claims the tax acts directly against a policy of extending UK business links to the "farthest reaches of the globe". The tax is set to rise again in April to £150 for some long-haul flights. In a report, BIG said it should be cut by 50%, then scrapped altogether. Grant Shapps, the former international development minister who leads BIG, said Prime Minister Theresa May needs to make good on a promise she gave on Monday to "forge a bold, new, confident future for ourselves in the world". He said: "Particularly post-Brexit, now is the time to do it." He added that reducing air passenger duty (APD) could provide an immediate "Brexit dividend" because the government would not have to wait until Article 50 is triggered to make the cut.

Company news

CRH (LON:CRH, 2,746.00p) – Hold
CRH plc, the international building materials group, yesterday issued a Trading Update for the period 1 January 2016 to 30 September 2016. As expected, third quarter trading benefited from continued growth in the Americas, albeit at a more modest pace than in the first half which benefited from favourable early season weather; in Europe momentum also remained positive. Cumulative sales amounted to €20.4 billion for the nine months to the end of September, an increase of 22% compared with the corresponding period in 2015. On a proforma basis, sales were 6% higher than 2015. EBITDA for the nine months to the end of September was €2.4 billion, an increase of 14% on proforma 2015. Proforma sales in the Americas for the quarter were up 1% compared to Q3 2015 while proforma EBITDA improved by 11% reflecting a strong margin improvement. For the full year, EBITDA from the territory is expected to be in excess of €1.9 billion based on a projected average full year 2016 US dollar/euro exchange rate of 1.11. European proforma results in the first half of this year were ahead of the strong first half of 2015 and, on the back of continued recovery in some key markets, proforma sales and EBITDA were also ahead of Q3 2015. Assuming normal weather patterns for the remainder of the year, management expects Europe EBITDA for 2016 as a whole to be in excess of €1 billion. The newly formed Asia division reflected results from the Philippines operations acquired as part of the LH Assets in the second half of 2015 together with CRH Asia's divisional costs. Proforma results in the first half of this year were ahead of the first half of 2015 and on the back of favourable underlying demand fundamentals in the Philippines, proforma sales and EBITDA further advanced in Q3 compared to 2015. With the ongoing demand backdrop, we expect Asian EBITDA for 2016 as a whole to be in excess of €100 million. Separately, the Group's investments in India and China are equity-accounted and CRH's share of profit after tax from these businesses was reported in profit before tax along with the Group's other equity-accounted investments. For the full year, the Group's share of profits from equity-accounted entities is expected to be approximately €30 million (2015 reported: €44 million), reflecting the sale of certain investments in 2015 and reduced performance in some markets. Net finance costs are expected to be broadly similar to last year (2015 reported: €389 million) as the non-recurrence of a cost of €38 million charged in 2015 for the early redemption of a portion of the US$ bonds is expected to be offset by the cost of increased debt in 2016. CRH will report its Preliminary Results for full year 2016 on Thursday, 2 March 2017.

Our view: CRH reiterated its guidance for 2016E EBITDA. Despite significant currency headwinds, the year's overall EBITDA outturn is estimated to be in excess of €3 billion, more than 35% ahead of last year (2015 reported: €2.22 billion); this expected outturn includes a full year contribution from 2015 acquisitions and is after taking into account the impact of divestments and one-off items. While growth tempered slightly during Q3, with Americas sales rising just 2%, compared with some 13% in H1, while trend in Europe and Asia was roughly unchanged. Realistically, given the recent record of more than delivering on expectations, an outcome of as much as €3.15 billion and upside remains given the fact that sales and EBITDA remain quite substantially below previous peak levels. 2017 could also see the Group return to the acquisition trail, given management's apparent comfort with the concept of gearing the enterprise back up, which suggests targets of value over US$2 billion which, in turn, could provide a 5% to 8% boost to eps in the relatively short-term, based on historical integration benefits. Meanwhile, of course, CRH is considered one of the obvious beneficiaries of Trump's election pledge to spend around US$600bn in 'rebuilding and modernising' US infrastructure. The share price has spiked upward, copying its US benchmark sector peers, in celebration, even though many questions regarding the necessary funding remain and the fact that it is likely to be some years before such opportunity is actually seen at the earnings level. Nevertheless, the Group's relentless focus on performance in all its businesses, coupled with its vertically integrated business model for heavyside materials, should continue to deliver good operational leverage underpinning improved margins and returns. Having performed quite exceptionally over the past six months, however, which now places the shares on a 2016E P/E multiple of 20.5x, followed by 17.1x in the following year, along with yields of 2% and 2.2%. That suggests the shares have gone far enough for now, with Beaufort's upgraded price target of 3000p indicating less than 10% upside. A high-quality materials company, but Beaufort keeps its Hold rating on CRH shares at this time.

Kier Group (LON:KIE, 1,403.00p) – Buy
Kier Group, a leading property, residential, construction and services group, yesterday provided trading update for the period from 1 July 2016 to yesterday ('year-to-date'). The Group confirmed that it is on track to meet its full year expectations, which, the results are weighted towards H2. On the operational front, its Property division is on course to deliver a full year ROCE in excess of its 15% target and the pipeline remains healthy, with a valuation of more than £1bn. Residential division continued to benefit from the strong housing demand in the UK, with sales, visitor and reservation rates ahead of last year. Construction division and service division performed in line with expectations and the current order book for both already reached targeted revenue for the FY2017. Margin for Services division also meet expectations. The Group said "We are encouraged by the recent Government announcements relating to Hinkley Point C and Heathrow airport, which reflect the UK Government's commitment to further investment in infrastructure, a key sector for Kier. With our broad offering and presence in sectors receiving Government focus, the Group is well-positioned for the future and looks forward to the Government's Autumn Statement on 23 November."

Our view: The Group said it remains on course to meet full year expectations, despite increased economic uncertainty in the UK following the EU referendum. The uncertainty, however, has been eased slightly with the Group witnessed UK Government's commitment on both Hinkley Point C nuclear power plant and 3rd runway at Heathrow Airport, thereby reassuring the electorate of its willingness to continue making investment in domestic infrastructure. Looking ahead, the Group expect average net debt for the six month period ended 31 December 2016 to be £300m, in line with the prior year (FY2016: £280m), reflecting £75m proceeds from the disposal of Mouchel Consulting and £100m investment in the Property and Residential divisions post the period. The Group also expect to maintain a net debt to EBITDA ratio of less than 1x at 30 June 2017. Valued at FY2017E and FY2018E P/E multiple of 12.7x and 11.5x along with dividend yields in excess of 4.8% and 5.1% respectively, Beaufort continue to rate Kier Group as a Buy.

Royal Mail (LON:RMG, 464.00p) – Hold
Royal Mail, the UK's designated universal postal service provider, yesterday announced its results for half year ended 25 September 2016 ('H1 FY2017'). During the period, revenue advanced by +1% to £4,583m and operating profit before transformation costs fell -1% to £206m, against the comparable period (H1 FY2016). Pre-tax profit fell by -5.2% to £110m and earnings per share also declined by -2.3% to 8.6p. On an adjusted basis, operating profit before transformation costs fell -5% to £320m but due to less transformation cost during the period of £58m, operating margin improved by +0.4% and therefore pre-tax profit grew by +5% to £252m, resulting earnings per share rose to 19.2p from 18.1p. Looking at the revenue at an underlying basis by each division, UKPIL (UK Parcels, International & Letters) declined -1% whereas GLS (General Logistics Systems) advanced +9%. Net debt widened by -22.5% year-on-year to £452m. Looking ahead, the Group lowered full year transformation costs guidance to £130m-160m from £160m. It also targeting up to -1% reduction in underlying UKPIL operating costs before transformation costs during FY2017. The Group revised up the total cost avoidance target from £180m to £225m of UKPIL operating costs for FY2017 and said it reaches c.£600m of annualised operating costs cumulative over the 3 year period ending FY2018. Net cash investment also reduced to "no more than" £500m per annum (previously guided £550m-£600m), compared with an average of £615m over the last 3 years. Royal Mail's CEO, Moya Greene commented "Our performance was broadly in line with our expectations. We remain very focused on improving our products and services, controlling costs, improving the efficiency of our spending and investing in new areas to support growth. As in previous years, the outcome for the full year will be dependent on our performance over the important Christmas period." The Group declared an interim dividend of 7.4p per share, up +6.1%.

Our view: Royal Mail delivered a somewhat disappointing performance during the half-year period, due to challenging market conditions which resulted from slowing economic growth, low inflation, and intense competition. Indeed, readers might recall Beaufort reciting a similar sentence at the time of FY2016 final results and before. Royal Mail points out that UK letters and parcels markets are, quite understandably, correlated to movements in GDP, and therefore to the general health of the UK economy. While advertising letter volumes might be directly linked to this (revenue down -8% in H1), the lack of organic growth is confirmation enough, if any were needed, that the customer are fundamentally and irrevocably switching to electronic communications while deserting traditional paper delivery. Companies are likely to increasingly adopt electronic direct mailing for advertising as well, which will be cheaper, delivered immediately while having the capability to observe statistical data/behaviour of the receivers. With a 4-6% decline per annum in addressed letter volumes expected by the management, GLS is now the only driver of revenue growth for the Royal Mail. GLS saw resilient revenue growth of +9%, along with underlying volume growth of +10%, during H1 benefitting from it rather belatedly seizing the opportunity to enter premium B2C business as another route to capture e-Commerce growth. Royal Mail also increased its Asian channels by building partnership with Alibaba Group, the Asian e-Commerce company, and China Post, although the parcels market itself remains highly competitive as Amazon Logistics and a myriad of other me-too players compete for market share. The Group cut back on investment spending and forecasts improved cost saving, but this alone cannot provide the improving strategic picture shareholders are demanding. With a complicated UK economic outlook, pension affordability, wage inflation and Union issues to confront, we consider the Group's current FY2017E and FY2018E P/E multiples of 11.6x and 11.2x, with dividend yield of 5% and 5.2%, to now fairly value the shares. Beaufort therefore downgraded Royal Mail to Hold from Buy.

Watkin Jones (WJG.L, 118.25p) – Speculative Buy
Watkin Jones, the leading UK developer and constructor of multi occupancy property assets, with a focus on the student accommodation sector, yesterday provided a trading update for the year ended 30 September 2016. The Board expects to report a successful financial year with trading in line with its expectations. As announced on 27 September 2016, the Group successfully completed, ahead of the 2016/17 academic year, ten developments across the UK with a total of 3,819 student beds. Watkin Jones has a record of on-time delivery of schemes and all developments expected to be completed ahead of the 2017/2018 academic year, remain on track. The Group continues to add sites to its strong development pipeline and, at 30 September 2016, it had a total of 21 developments with 6,814 beds targeted for delivery during 2017 and 2018. Its pipeline beyond 2018 is also looking robust with over 2,000 beds across a number of sites already secured. This includes the proposed redevelopment of the Duncan House site in Stratford, London, to provide 511 beds of student accommodation, 44 residential apartments and approximately 28,000 square feet of academic and office space. The scheme has a gross development value in excess of £100 million and is due for delivery in 2019. Fresh Student Living, the Group's asset management subsidiary, continues to progress well, and now has 12,337 beds under management for the 2016/17 academic year (8,310 under management during the 2015/16 academic year). It will be announcing final results on Wednesday, 18 January 2017.

Our view: While this excellent progress does not come as a great surprise, it conveniently reminded us that Watkin Jones' management is operating the right business model at the right time. The alternative asset class of Privately Built Student Accommodation offers both excellent cash flow visibility and highly stable property-sector yields from operations that tend to be well insulated from underlying economic activity. As such, it is able to pre-sell and forward-fund its projects through a long list of hungry institutional buyers – like M&G, L&G, AIG etc. - creating an ideal high return, high visibility, capital light model that is almost unique in the world of residential development. With just 6% of the UK's total full-time student population currently occupying PBSA (Purpose Built Student Accommodation), at a time when government legislation is limiting HMO (House in Multiple Occupation) supply and introducing higher stamp duty on buy-to-let property, the sector is expected to enjoy quite significant growth for years to come while capital growth continues to sharpen returns. Significant demand headroom in all regions, suggests little or no impact should Brexit manage to dissuade some EU students from seeking UK educations. The shares have performed reasonably well since IPO, but there is still more to go for. The Group is set to deliver double digit earnings growth (implying a 2016E P/E of 8.9x, followed by 7.9x) for the next several years, with tightly controlled operating costs combined with a generous progressive dividend. With significant net cash still in hand following the IPO, management remains confident enough to project a yield to September 2016 of over 4% (based on second-half payment only), followed by 6.2% for full year 2016/17; beyond this, surplus generation could also find its way into shareholder's pockets through specials as well. Beaufort sees good value in Watkin Jones and now raises its price target to 148p (125p previously) on the shares, which it recommends to both income and growth investors.


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