Stocks Update 25/02/2022

BOCH – FY results

CLIN – Interims

HMSO – Disposal

IAG – FY results

LLOY – FY results

MKS – New partnership with Clinique

SN/ – FY results

SPDI – Arcona update on Ukraine

Developments in the markets this week have been overshadowed by the barbaric actions of the Putin administration. My deepest sympathies are with the heroic people of Ukraine.

BOCH – FY results

Bank of Cyprus released its FY results on Monday and these show significant progress. The Group, which has a market cap of only c.€500m, delivered underlying net income of €91m in the year. It is guiding >10% ROTE by 2025, which implies a PE for that year of just 3x. More on this later. Lending has picked up as the economy has moved out of the COVID shock. New lending in 2021 was +33% y/y at €1.8bn and is recovering towards pre-pandemic levels (€2.0bn in 2019). Non-legacy net loans rose to €9.37bn at end-2021 from €9.00bn at end-2020, offsetting most of the drag from the ongoing run down of legacy loans. While the run-down of legacy loans weighed on net interest income, non-interest income improved to €285m last year from 2020’s €237m and is now back to within 10% of 2019’s pre-COVID high of €307m. A key part of the Group’s strategy to grow its non-interest income is its insurance businesses, which have market shares of 25% (life) and 13% (non-life) respectively. BOCH has the ambition to lift these towards the Group’s share of lending in Cyprus (39%). Interestingly, management say that it intends to “explore market opportunities from performing loan trades in Cyprus” which might hint at an exit for a peer in what is a remarkably overbanked market (Cyprus has a population of 1.2m and there are 29 banks on the Register of Credit Institutions at the Central Bank of Cyprus). Costs have been a focus for management, which has pared headcount, closed branches and exited non-core markets. OpEx and the  C/I ratio were flat at €347m and 60% y/y respectively. The Group had a targeted voluntary redundancy programme in Q4 which should cut costs by €7m/year going forward.

The Group has a very strong capital position. Its CET1 ratio is 15.8%, pro-forma for the Helix 3 NPE sale. This is +100bps from end-2020 and provides significant headroom over the current minimum CET1 requirement of 10.1% and management’s target of 13.5-14.5%. RWAs are €10.3bn (pro-forma for Helix 3) so this implies surplus capital of €134-238m or somewhere between a quarter and a half of the current market cap. Asset quality is an area where the Group has delivered dramatic progress. The shedding of non-performing exposures has pared the NPE ratio to just 7.5% at end-2021 (pro-forma for the Helix 3 disposal, 12.4% before taking that into account) vs 25.2% (not a typo) at end-2020. Management see it falling further to c.5% by end-2022 and to <3% by end-2025. The 2021 cost of risk was 57bps, well below the 100-118bps annual outturns over 2018-2020. Management is guiding normalised impairments at 40-50bps. The Cyprus economy is forecast to grow by 4.3% this year and by 3.3% in 2023. The Group’s stock of held for sale properties (REMU) contracted by 17% (from €1.5bn to €1.2bn) during 2021, with disposals averaging an 11% premium to book value.

As I had predicted, management is signposting the commencement of distributions to shareholders from 2023, subject to performance and relative approvals. This should, all else being equal, broaden the constituency of buyers for BOCH stock. In November 2020 management set a target for a medium term RoTE of c.7%. On Monday they upped that target to >10% by 2025, versus underlying ROTE of 5.5% in 2021. This does not seem undemanding as income rebuilds post-COVID-19 and the quality of the loan book has been transformed for the better through the NPE disposal programme. BOCH had tangible equity of €1.6bn at end-2021, so this implies net income of >€160m by 2025, putting the company on a PE of just 3x for that year. On another conventional valuation metric, P/TNAV, BOCH is on 0.3x (i.e. trading on a circa two-thirds discount to tangible net assets) 2021 NAV. Given its strong market positions (a 39% share of new lending and 35% deposit share in Cyprus), capital strength and clear plan to lift returns above the cost of equity, I suggest that this stock would still be very cheap at double the price.

IAG – FY results

On Friday IAG released its FY results. While performance was significantly negatively affected by COVID-19, the operating loss of €3.0bn was nonetheless in-line with guidance. The exit performance was much better, with a loss of €0.3bn in Q4 at the operating level, and EBITDA positive to the tune of €250m. Even more encouraging, the Group delivered €1bn of operating cash flow in H2, while net debt of €11.7bn reduced by €0.7bn in Q4, as bookings picked up. The Group is guiding a much better performance in 2022, with capacity to return to 85% of 2019 levels and the Group to be “significantly profitable” and generate “significantly positive” cash flows. Management is guiding for meaty capex of €3.9bn this year, some of which reflects deferrals of capex following the onset of COVID-19 – capex was €1.9bn in 2020, €0.7bn in 2021. The Group is guiding for an increase in net debt this year as a result. However, with liquidity of €12bn at end-2021, it is well placed to meet the €3.9bn of capex and debt maturities (the profile of which is very undemanding, totalling €7.5bn in the period to end-2029). Bloomberg consensus has IAG on 6.6x 2023 earnings, falling to 4.9x in 2024 as earnings rebuild. Consensus net debt is €13.1bn at end-2022, falling thereafter (€12.8bn at end-2023, €12.0bn at end-2024). Net debt/EBITDA is therefore unlikely to fall below 2x until 2025, which bears consideration despite the optically low multiple IAG trades on.

LLOY – FY results

Lloyds Banking Group released its 2021 results on Thursday. All the key numbers are moving in the right direction, with net income +9% y/y; ROTE +11.5pt vs 2020; TNAV +10%; CET1 +10bps, pro-forma for distributions; and management has declared £3.4bn of shareholder returns, equivalent to >10% of market cap, with £2bn of this coming in the form of a buyback (which should lower the share count by more than 5%). Costs were +1% y/y but that’s not unexpected given the return of variable pay post the initial COVID shock. The Group has been securing cost efficiencies elsewhere, such as through increased digitisation and a 9% contraction in office space last year, but OpEx is guided to increase by £0.5bn to £8.8bn in 2022 mainly through the inclusion of restructuring costs ‘above the line’. Average interest earning assets were +2% y/y and the NIM broadened by 2bps (to 254bps) last year. Management see it rising to 260bps this year. There are signs of life in consumer credit, with credit card balances rising £0.5bn in H2 after a £0.2bn contraction in H1. On asset quality, the Group saw a net writeback of £1.2bn in 2021 and is guiding for a charge of c.20bps this year. Returns were flattered by this writeback in 2021, but ROTE is guided to be c.10% in 2022. On capital, the CET1 was 16.3% and this is well above the 13.5% target, pointing to further buybacks and growth in dividends from here. Management also unveiled its strategy update, with plans to grow revenues, maintain cost discipline and uplift returns. Not unlike Bank of Cyprus, LLOY sees scope to grow non-interest income market shares to closer to the Group’s lending market shares. It is targeting £1.5bn of annual revenue growth from these initiatives by 2026 vs an investment of £4bn. Double digit ROTE warrant LLOY trading on a premium to TNAV (57.5p), instead of the current discount, in my view.

SN/ – FY results

Smith + Nephew released its FY 2021 results on Tuesday. Revenue was $5.2bn, +14% y/y and in-line with consensus, as health services continue to normalise following the initial COVID-19 shock. EBITDA of $1,316m was just $2m below Bloomberg consensus. Adjusted EPS of 80.9c was a touch below Bloomberg consensus of 82.8c. Net debt was $2.05bn, again in-line with consensus ($2.03bn). In terms of the rebuild in activity, it is encouraging to see that Sports Medicine & ENT and Advanced Wound Management revenue are both above pre-COVID levels, while Orthopaedics’ performance was impacted by supply chain constraints. Helped by operating leverage, operating profit doubled to $593m (2020: $295m). A full year dividend of 37.5c has been declared, in line with 2020 and 2019, while the Group is commencing “a new regular annual share buyback” programme in 2022. A new CEO, Dr. Deepak Nath, will take over from Roland Diggelmann on 1 April. On the outlook, management is assuming underlying revenue growth of 4-5% for this year (with growth held back a bit by supply chain constraints), and 4-6% by 2024, structurally ahead of historical levels, and a trading profit margin of at least 21% by 2024 (2021: 18%, +3pc versus 2020). Koyfin has SN/ trading on c.18x earnings, which seems undemanding given the backdrop of a recovery in sales and earnings allied to the long term structural kicker from rising prosperity and ageing populations.

SPDI – Arcona update on Ukraine

Arcona, the Dutch listed property group that SPDI is transferring its property assets into in exchange for shares, provided an update yesterday on its exposures to Ukraine. Its latest disclosed portfolio exposure to the country is just 4.2% / €3.4m, with a further €2.0m of SPDI Ukrainian property assets scheduled to transfer across (although, at a minimum, the timing of that is now very uncertain). For its part, SPDI has not provided any market update.

MKS – New partnership with Clinique

On Tuesday Marks & Spencer announced a new online and in-store partnership with the skincare and make-up brand Clinique. From this summer c.500 Clinique products will be available on M&S.com for free next day delivery or click and collect to >700 locations. In addition, 34 M&S stores in the UK and Ireland will have a Clinique counter, with a further 40 stores having a bespoke Clinique ‘fixture’ for product display. MKS has been successfully adding third-party clothing brands (Nobody’s Child, Jaeger, Sosandar) to its online platform, and with c.15% of M&S Clothing & Home customers also buying beauty lines last year, this is a logical extension of the partnership strategy, offering a seamless and convenient shopping experience to the Group’s 22m customers.

HMSO – Disposal

Hammerson said on Monday that it was in discussions with Redical Holdings AG on terms for a possible sale of its Victoria Gate and Victoria Quarter shopping centres. HMSO said that “the pricing under discussion is £120m” and that it is motivated by its strategic ambition “to realign its portfolio to focus on prime urban estates through disposals of non-core assets, to strengthen the balance sheet, and to recycle capital into its core portfolio and its development pipeline”. On Friday HMSO confirmed that this sale had completed for the guided £120m price, with proceeds used to reduce net debt. The disposal price represents a net initial yield of 7.4%, which seems like a lot of yield to give up given that HMSO’s annualised cost of debt (based on the H1 outturn) was 4.9%.

CLIN – Interims

Clinigen released its H1 (to end-December) results on Wednesday. With the Group set to be taken over in the coming weeks by Triton, these are only of academic relevance. Nonetheless, it was reassuring to see a good performance in the period, with reported net revenues +10% y/y and EBITDA +6% y/y, in-line with unchanged guidance of EBITDA growth of 5-10% for the FY. The Scheme of Arrangement is expected to become effective on 4 April.