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Five Shares to Watch – Half Year Update

Nicholas Hyett, Equity Analyst, gives a half year update on this year’s five shares to watch: DS Smith, WPP, Ibstock, Novo-Nordisk and Keywords studios.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

With the outlook for the remainder of the year still very uncertain we’ve pulled together our thoughts on the outlook for each of the five shares to watch going forwards.

This article isn’t personal advice. If you’re not sure if an investment is right for you please seek advice. All investments fall as well as rise in value, so you could get back less than you invest. Past performance should not be seen as a guide to the future.

Investing in individual companies isn’t right for everyone. Our five shares to watch are for people who understand the increased risks of investing in individual shares. If the company fails you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

You can get more comment on the stocks listed here sent straight to your inbox by signing up to research updates.

It’s been a difficult first half for our five shares to watch. We’re disappointed to say the five, on average, delivered a negative total return of -13.0% in the first 6 months of the year. Unsurprisingly it’s the more cyclical WPP, Ibstock and DS Smith which account for all of that decline. However, strong performances from Novo-Nordisk and Keywords mean that, as a whole, our five are 4.9% ahead of the market, which delivered a total return of -17.8%.

DS Smith

The impact of coronavirus on DS Smith has been mixed.

On the one hand consumer goods and e-commerce customers account for a large slice of overall sales, and these industries have navigated the crisis reasonably well. However, demand from industrial customers has been much weaker, and pre-existing weakness in the market price of paper has had negative consequences for the group’s North American paper manufacturing and export businesses. As a result full year revenue fell 2% in the last financial year.

While margins have improved overall, supporting a 4% increase in underlying operating profits, adapting manufacturing facilities to meet social distancing requirements has cost money. However, the bigger challenge has been caused by increased recyclate prices (a key source of raw material for paper manufacturing) as the virus disrupts collections. That’s expected to negatively impact profits in the current financial year.

Full year results, which were announced in early July, showed a modest fall in overall net debt. That’s largely thanks to the sale of the group’s remaining plastic packaging business. But with the economic outlook uncertain and profits expected to be lower, net debt to cash profits looks set to be higher than either we or management would like.

Keeping the balance sheet in good order through the current disruption led management to cancel the half and full year dividends. Capital spending has been cut as well as any non-essential operating expenditure. If the current disruption continues for any length of time we wouldn’t be entirely surprised if the dividend hiatus continued until the end of the next financial year.

However, putting the immediate challenges to one side, we think DS Smith’s long term attractions are unaffected, and might have even improved. The shift to e-commerce during the crisis is good news, and the trend towards non-plastic packaging has continued to gain traction. In the long term being able to reduce debt now should support investment and create the right environment for a healthy and growing dividend, but of course there are no guarantees.


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The closure of much of the UK housebuilding sector saw Ibstock’s brick sales slow to a trickle. The concrete business has performed better, thanks to greater exposure to infrastructure and repair and maintenance markets, and the loosening of lockdown rules have seen some of the group’s factories reopen. However, demand seems likely to remain subdued.

Net debt rose from £85m at the start of the year to £105m at the end of May. And while a £215m revolving credit facility provides a fair degree of headroom, especially since its covenants (conditions imposed by lenders) have been relaxed, the disruption and uncertain outlook means cash preservation is the order of the day.

The dividend was dropped early on and as many as 15% of the company’s employees are likely to be affected by restructuring proposals. Capital expenditure previously intended to increase overall capacity has also been put on hold.

For all managements’ efforts it’s the pace of recovery that will ultimately determine Ibstock’s fortunes from here. A V-shaped recovery, especially among housebuillders, will see the company emerge with more debt but otherwise the damage should be limited. Recent updates from certain housebuilders seem to suggest demand for new houses is weathering the crisis better than we expected – a welcome relief.

However, an extended period of reduced demand would probably see the company turn to shareholders for additional funds. That could lead to significant dilution and dividends being off the table until the immediate crisis is past and the balance sheet is restored.

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Keywords has weathered the current disruption rather well, moving over 6,000 staff to working from home in pretty short order.

Gaming is one of the few sectors that might have benefitted from the lockdown – as increasingly large numbers of us were looking for entertainment at home. However, as a provider of services to game developers, rather than owners of games themselves, that cash hasn’t necessarily found its way through to Keywords. In fact one survey suggests 29% of gaming service providers fear insolvency if the current crisis were to drag on for an extended period.

Fortunately Keywords’ size and a fairly healthy balance sheet means we don’t think the group’s at risk. It started the year with net debt of just €17.9m, and while there has been disruption, revenues in March and April were still 7% ahead of the same period last year.

In fact management have taken advantage of the group’s higher share price, currently trading on a PE ratio of 38.2, to issue £100m of new shares. The extra cash is intended to provide the firepower to snap up struggling independent rivals.

Acquisitions have long been a key part of the group’s strategy to become the go to provider of outsourced services to the computer games industry. Buying opportunities at lower prices would certainly be welcome, but discipline is still important and a careless buying spree could be damaging. Something we’ll be keeping an eye on.

Overall we’re pleased with how Keywords has performed so far. Revenues continue to improve, but we do worry that profits haven’t kept pace. Coronavirus means that trend is likely to continue this year and with the stock trading on a fairly intimidating PE ratio we’re more cautious going forwards.

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To say Novo-Nordisk has shrugged off the current crisis is perhaps overstating it, but it’s certainly performed well. Aside from a moderate stockpiling of insulin, which saw demand increase, there has been very little direct effect on the group.

The group’s growth engines continue to perform well – with sales of GLP-1 diabetes treatments rising 40%. That reflects increased uptake of Ozempic but also the launch of Rybelsus (the world’s first GLP-1 in tablet form) in the US. We think that bodes well for the rest of the year.

Insulin pricing in the US remains under pressure. And while the group’s managing the impact well, largely thanks to growth in other areas of the world, we worry the current crisis will result in increased scrutiny of pharmaceutical pricing around the world. That could be problematic in the long term.

It’s worth noting that the shares have enjoyed a strong run year-to-date, and now trade on a PE ratio of 22.8 times. That’s nearly 10% above the long run average. However, with interest rates at an all-time low and the current uncertainty we think that’s probably well justified.

Novo’s net cash position, defensive market and a prospective dividend yield of 2.2% remains distinctive. Remember though that yields are variable and are not a reliable indicator of future income.

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As one of the world’s largest marketing groups, a global economic downturn was never going to treat WPP well.

Marketing budgets are often among the first casualties in a downturn and early signs are that the current crisis is no exception. ITV reported a 42% fall in advertising revenue in April, and even Facebook has struggled, with 17% growth in first quarter advertising revenue falling to 0% in the first 3 weeks of April.

However, WPP’s problems are deeper than the turn in the market cycle, and we’re very disappointed with how the group has performed. Underlying revenue fell in the first two months of the year having stabilised at the end of 2020. The coronavirus outbreak has only made matters worse.

Fortunately there’s some silver lining hidden in the sea of red.

Thanks to the sale of a stake in market research group Kantar the balance sheet is looking in a much better state than it was a year ago – with net debt down from £4.6bn to £2.8bn at the end of the first quarter. Cash on hand and existing debt facilities mean WPP has access to £4.4bn in short term funding.

The all-important North American market was the group’s best performing region last quarter, although it still saw underlying revenues shrink 1.9%. However, it took until late March for lockdowns to really get underway in the US so we’re cautious about what the next set of numbers will bring.

Management are clearly bracing for a bad spell. Moves to cut the dividend and sizeable share-buyback programmes are set to save £1.1bn this year. Capital spending is under the axe too, with pay cuts and redundancies likely or already delivered. However, even the most efficient company will struggle to make money if revenues are in free fall, and WPP is far from the most efficient company we can think of.

WPP was always a recovery play – which is an inherently higher risk proposition – but CEO Mark Read now has to deliver that during a cyclical downturn no-one saw coming. A far harder ask.

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The author of this article holds shares in DS Smith.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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