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Investors Chronicle: Segro, RPS, HSBC

Buy: Segro (SGRO)

Segro still retains its fundamental attractive points: continued like-for-like rental growth, scale and exposure to strategic regions on the continent. The warehouse sector is maturing, but we still think the growth potential justifies the premium to forecast net asset value, writes Lauren Almeida.

Shares in Segro have grown in value by more than 40 per cent over the past year. The group, which develops and manages warehouses, has been flying high on the rise of ecommerce and growing urban areas — which is “really where the action happens”, according to chief financial officer Soumen Das.

Yet there are concerns that the sector, once undersupplied due to the lack of development following the 2008 crisis, is now beginning to mature. But this year the company reported that the like-for-like value of its portfolio, driven primarily by growth in continental Europe, is up by 13.5 per cent.

“There is still very good performance in the UK, but with fireworks more on the continent — they’re playing catch up,” said Mr Das, who cited rising ecommerce penetration rates in France and Germany where retailers will soon need to adapt their supply chains to omnichannel delivery models.

On home turf, Segro’s performance was steady: like-for-like net rental income in the UK rose by 5.7 per cent. Total net rental income was up 13.6 per cent to £281.3m from £247.6m last year, which management attributed in part to investment activity and development completions. The group noted that 2019 was its record year for completions and has invested £692m in its portfolio, with total development capex for 2020 expected to exceed £600m.

Analysts at Panmure Gordon expect adjusted net asset value of 736p a share at the December 2020 year end.

Sell: RPS (RPS)

Service groups such as RPS should benefit from the start of the new regulatory cycle for the water industry, but the Australian property market remains weak and uncertainty persists in the UK, writes Nilushi Karunaratne.

RPS’s statutory operating profit plunged over three-quarters to £10.9m in 2019, weighed down by a £19.8m impairment on its Australian business. As described at the half-year stage, state elections there disrupted infrastructure spending while the federal election delayed major defence projects. This was in addition to a subdued property market. Conditions improved in the second half, but the rally was weaker than anticipated.

Adjusted operating profit from consulting was flat year on year at £15.1m as UK political uncertainty delayed clients’ investment decisions. Lower demand hit higher-margin business lines, pushing the division’s margin down 0.9 percentage points to 11.8 per cent. Although domestic fee income may grow in 2020, the group has warned profit will probably fall as it invests in new enterprise resource planning software.

Energy was the only segment to increase earnings as oil and gas markets recover — adjusted operating profit jumped over a fifth to £11.1m. The proportion of revenue derived from advising clients on renewables, especially offshore wind, is increasing.

With £10.1m spent on acquisitions and higher capital expenditure, net debt (excluding £50m in lease liabilities) rose 27 per cent to £94.1m. Equivalent to two times adjusted cash profits (Ebitda), this is at the top of the target leverage range. Meanwhile, free cash flow dropped from £32.8m to £7.7m.

Numis forecasts adjusted pre-tax profit of £37.3m and earnings per share of 12.1p in 2020, rising to £41m and 13.2p in 2021.


It is tempting to assume that a forward yield of 7 per cent provides downside protection to HSBC shares, but earnings coverage will remain very thin for the next two years, as the incredibly complex drive for simplicity is carried out in tough conditions, writes Alex Newman.

A strong common equity tier-one ratio — which management has pledged to maintain at between 14 per cent and 15 per cent — and growth opportunities prevent us turning bearish, though this is looks like an increasingly risky hold.

Investors expected pain from HSBC’s restructuring, details of which were published this week with full-year numbers. Yet the sheer scale of the overhaul understandably sent many scurrying for cover.

Central to the repair job is a $100bn (£77bn) reduction in risk-weighted assets (RWAs) by the end of 2022 and the redeployment of capital from underperforming investment banking teams in Europe and the US to higher-growth regions, including Asia and Mexico. This, alongside cuts to US retail operations, sales and trading in Europe, and a merger of the group’s global private banking and retail divisions, will result in tens of thousands of job losses.

The financial implications are massive. Though it is expected to yield cumulative savings of $4.5bn, 90 per cent of the restructuring’s $6bn cost will fall in the next two years, which has resulted in the suspension of share buybacks until at least 2022.

Unfortunately, the backdrop for such a radical overhaul is ugly. While adjusted fourth-quarter figures were slightly better than expected, a downgrade to interest rate forecasts led to a $7.3bn goodwill impairment to reported numbers. Even more worrying, chief financial officer Ewen Stevenson warned of slowing revenues in Hong Kong and mainland China, RWA inflation, and up to $600m of loan impairments should the coronavirus outbreak endure into the second half of 2020.

Given this environment, and the complexity of restructuring — which apparently includes more than 200 separate cost-cutting initiatives — it is baffling that Noel Quinn is yet to be formally promoted to the role of chief executive. Chairman Mark Tucker defended the speed of the hiring process, though one wonders how quickly an external candidate could familiarise themselves with the job at hand, to say nothing of potential gardening leave.

Analysts at Shore Capital forecast adjusted net tangible assets of 719 cents at the December 2020 year-end.

Chris Dillow: Cheap — for a reason

Despite its recent rise, the important fact about sterling is that it is still low. If we adjust for differences in consumer price levels to get a measure of the real exchange rate the pound is 17 per cent below its post-1999 average against the US dollar and only slightly above the post-1985 low it hit soon after the EU referendum. And even against the euro — which has been weakened by the region’s negative interest rates and feeble economy — sterling is 4 per cent below its post-1999 average.

This matters. Exchange rates have behaved like share prices in one important respect: they have often overshot fair value and so become too cheap or too dear. Martin Eichenbaum, Benjamin Johannsen and Sergio Rebelo have shown that the real exchange rate has been a good predictor of subsequent changes in the nominal rate, with low real rates leading to rising nominal rate in the following months.

Recent history shows that this is true of sterling. Since 1996 the correlation between the real euro/sterling rate and the subsequent three-yearly change in the nominal rate has been 0.39. For the dollar/sterling rate, the correlation has been 0.53. These might not seem very high, but given the volatility of exchange rates and the fact that many economists have found them to be otherwise unpredictable, they are significant.

This seems to suggest we should expect sterling to rise in coming months, and hence to see losses on some overseas investments.

Or should we?

There’s an obvious problem with this inference. Sterling could be cheap for a good reason because post-Brexit trade frictions will reduce long-term growth; the think-tank The UK in a Changing Europe estimates this will reduce GDP by over 6 per cent by 2030 relative to what it would otherwise have been. This justifies a low exchange rate now because financial markets should anticipate lower real interest rates as a response to slower real economic growth.

Of course, markets do sometimes overshoot. But just as shares are sometimes cheap for a good reason, so too can be currencies.

If you want to be bullish of sterling, you must reject this argument. Can we do so?

One possible argument is that the job of supporting growth against the hit from Brexit will be done by fiscal rather than monetary policy. But we don’t know this yet: in particular, we don’t yet know whether the new chancellor will impose fiscal rules to restrain borrowing. If he does, monetary policy will stay loose.

Another argument is that the damage done by Brexit can be offset by growth-enhancing policies such as increased infrastructure spending.

Such optimism, however, runs into the problem pointed out by John Landon-Lane and Peter Robertson in 2003. They showed that, over the long run, developed economies tend to grow at similar rates. This, they infer, suggests that national governments can do much less than they think to stimulate longer-term growth.

But we can draw another inference from this — that economies are resilient to bad policies as well as to good. There’s considerable uncertainty about just how much damage trade frictions will actually do. While it’s plausible that slower growth in external trade will tend to depress growth, the magnitude of this effect is uncertain.

Of course, such uncertainties won’t be resolved for a long time — if, indeed, at all because we will never see the parallel universe in which we did not leave the EU. But they do mean there is room for markets to slightly reappraise their pessimism, especially if some kind of post-transition trade deal with the EU can be struck.

We cannot, therefore, rule out the possibility that sterling might have overshot and so might bounce back.

Brexit and long-term growth, however, are not the only issues. Sterling is a risky asset: as we learnt in the 2008 financial crisis it falls a long way in bad times. Buying sterling is therefore a bet that global investors won’t lose their appetite for risk. Even if sterling does rise, therefore, it would only be a reward for taking on risk. For retail investors especially, there is no easy money to be made in foreign exchange markets.

Chris Dillow is an economics commentator for Investors Chronicle


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