Investors’ Chronicle: Rentokil, ITV, Royal Dutch Shell


BUY: Rentokil (RTO)

The group has had an acquisitive six months, fuelled by a strong free cash flow performance, writes Arthur Sants.

Rentokil is an innovative opportunist. Last year, its disinfectant business benefited from the fear that Covid-19 could be caught from uncleaned surfaces. Its half-year results show that demand had tapered in the second quarter as the scientific community decided that the virus was more of an airborne threat.

The launch of its air purifying unit Viruskiller in the first half of this year is timely and the hope will be that it will offset some of the disinfectant scaling back in the second half of the year.

Most of the first-half growth came from its core pest control unit which increased revenue by 18.7 per cent, including 8.5 per cent organic growth. More revealingly, this represents 20 per cent revenue growth on a Covid-free first half of 2019. Disruption from the pandemic stalled the unit’s progress last year.

Despite some further problems caused by the pandemic, Rentokil has pressed on with its ambitious acquisition strategy, completing 24 deals in the year to date. This included 21 in pest control and two in hygiene, set across 13 countries across all its regions. Actual cash spent on acquisitions in H1 was £261m and it expects this to rise to between £450m and £500m by the end of the year. This acquisitive strategy has been aided by very strong free cash flow performance. The group generated £222m, up 78.5 per cent, even though it increased its capital expenditure by 9.1 per cent.

The solid performance during the pandemic confirms the belief that Rentokil provides a critical service that is well insulated from wider economic shocks.

Viruskiller may have generated only £3.2m revenue in the first half of 2020, which isn’t game changing, but it is evidence of an innovative company that is happy to move quickly to spot opportunities.

The shares are getting pricier, jumping 4 per cent on the morning of results, so they are now 10 per cent in advance of where they were when we reviewed the investment case In April. A forward rating of 32 times consensus earnings would be too rich for some tastes, but it compares favourably with competitors Rollins and Terminix and we envisage accelerated growth opportunities in the key US market.

HOLD: ITV (ITV)

The broadcaster turned in creditable figures for the half, though full-year comparators will be tougher through the second half, writes Mark Robinson.

ITV chief executive Carolyn McCall brought an end to speculation that the broadcaster was looking to capture a stake in BT Sport, but declined to comment on whether it would put in a bid for Channel 4, also the subject of media speculation.

The update came as the group revealed that half-year profitability was boosted by strengthening advertising volumes, the resumption of productions, and helped by a tightening rein on working capital, leading to £21m of savings.

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The group registered its biggest ever month for advertising revenue in June, due to the delayed Euro 2020 tournament and the return of the hugely popular Love Island series. Covid-19 locked in audiences through 2020, so total viewing fell 6 per cent over the period, yet registered users on ITV Hub were up 7 per cent to 34.6m.

Indeed, the first half saw the highest ever number of streams for drama viewing on the ITV Hub. The group also revealed that subscriptions for BritBox UK continued to ratchet up, increasing by over 10 per cent to around 555,000 at June 30 2021 from 500,000 in January despite the loosening of lockdown restrictions in the second quarter.

However, management tried to play down relative expectations for the remainder of the year, due to tougher comparators through the second half of the year, though it forecast advertising revenue would be 68 per cent higher in July and up as much as 20 per cent in August. So although half-year figures provide encouragement for shareholders, and the shares are priced at a lowly 10 times consensus earnings, the trading backdrop remains uncertain as advertising regulations continue to tighten and competition intensifies.

SELL: Royal Dutch Shell (RDSB)

A major dividend increase and $2bn in payouts are to come as Shell fights a company-changing Dutch court decision, writes Alex Hamer.

After “retiring” its $65bn (£47bn) net debt target this month, Royal Dutch Shell set dividend klaxons blaring, especially as the oil price remained over $70 a barrel (bbl). 

It has delivered, boosting the quarterly payout 38 per cent to 24¢, on top of $2bn in buybacks that will be completed in the second half. The turnround on last year, when the oil price crashed and Shell cut thousands of jobs globally, has come as Brent crude bounced back to stay above $50/bbl all year. Recent Opec-plus drama has kept the price high despite worries over the Delta-variant of Covid-19 hitting demand. 

Shell’s adjusted profit jumped 71 per cent between the June and March quarters this year, coming in 10 per cent above analysts’ consensus estimate at $5.5bn. 

Chief executive Ben van Beurden said the company’s “operational and financial delivery and strengthened balance sheet” had led the board to rebase the dividend to 24¢ a quarter. Management is facing a fight to roll back tough emissions targets set by a Dutch court this year, which the major would need to sell off assets to meet. 

The chief executive said Shell was “moving at pace” towards its net zero goals, which are weaker than those of others in the sector. This week, the company announced a final investment decision for the 100,000 barrels of oil per day Whale project in the Gulf of Mexico. 

Underlying cash profits for the quarter on a current cost of supplies basis (CCS) — Shell’s preferred profit measure — climbed almost a fifth to $13.5bn. This was up a quarter for the half, showing the turnround on last year. The upstream division drove this strong performance, with its $2.5bn in adjusted earnings a quarter ahead of expectations. 

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Despite the retirement of the $65bn goal, below which Shell said it would increase shareholder distributions, the company got very close. Net debt was $65.7bn at June 30. 

Earnings will probably remain strong for the rest of the year as long as oil prices remain buoyant, although oil and gas production will drop in the September quarter, with upstream production guidance set at 2.1-2.25m barrels of oil equivalent a day (boepd) compared to the June quarter’s production of 2.26mboepd. 

There is a broad view that the Dutch court decision, which ruled Shell had to cut its emissions by 45 per cent by 2030, will get watered down on appeal, given the oddity of governments forcing individual companies to change, but it has prompted important questions over emissions stewardship and the increasingly interventionist role of the courts. Answers will become clearer if Shell’s appeal fails. 

The industry is in a state of flux but investors are reaping the rewards of the oil bounceback. We are still bearish on Shell in the long-term, however.

Chris Dillow: The inflation threat to shares

To what extent is the past a guide to the future? This question is key to whether equity investors should be worried by the possibility of higher inflation.

Recent history suggests we have little to fear. For example, CPI inflation was above its 2 per cent target for much of 2005-07 and 2012-13 and yet shares did well then — much better than in 2015-16 when inflation was near zero. This tells us that above-target inflation need not be bad for equities.

Taking the post-1995 period as a whole, the correlation between annual CPI inflation and annual changes in the All-Share index has been a mere 0.14, meaning that above-average inflation is slightly better than not for the market. The correlation has been higher than this for oil and engineering stocks, but for several important sectors such as banks, retailers, tech stocks and utilities it has been close to zero. And no sector is significantly negatively correlated with inflation. This suggests that equity investors can pretty much ignore inflation as its impact upon the aggregate market and most sectors has been small.

This shouldn’t be surprising. To some extent, inflation is predictable, which means that it should be discounted by investors in advance. The data suggest this is largely the case.

But what about inflation surprises? One gauge of these is how inflation expectations change. We can measure such expectations by looking at the break-even inflation rate, the difference between conventional gilt yields and their index-linked counterparts. When we do this, we see that higher inflation expectations have in recent years been good for equities. Rises in them in 2010-11, 2016-17 and in the past 12 months were all accompanied by rising share prices.

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The evidence, then, seems clear. Equity investors should not be worried by rising inflation. If anything, it is good for the market.

Such evidence, however, could be very misleading. In recent years inflation expectations have been largely a measure of the state of the economy: they have fallen in downturns and risen in recoveries. And equities, of course, have the same pattern. This is why cyclical stocks such as construction and industrials have been better correlated with inflation expectations than defensives such as utilities and tobacco.

But this need not continue. It’s possible that inflation will rise so much or stay high for so long that it will lead to significantly higher interest rates. In such an event, investors might reasonably fear that tighter monetary policy will hurt economic activity and so sell equities and especially cyclicals. If this happens, the link between higher inflation expectations and higher share prices will break down.

There’s a precedent for this, though we have to go back to 1994 to find it. Back then inflation expectations rose significantly and equities fell as investors feared higher interest rates.

And that episode was typical of the 1980s and 1990s. In 1989-90 equities also fell as inflation expectations rose. By the same token, falling inflation expectations in much of the 1980s and 1990s were accompanied by rising share prices as investors believed that interest rates would fall thereby prolonging the economic upswing.

From today’s levels, therefore, it is quite conceivable that higher inflation expectations would hurt shares. To believe that shares are safe from inflation is to commit the recency error — the tendency to attach too much weight to recent evidence and discard relevant evidence from earlier periods.

In fact, it’s possible that rising rates now would do even more damage than history suggests. If years of near-zero interest rates have pushed people into equities simply out of despair at returns on cash, then a rise in those returns could have a disproportionately harmful effect upon the market.

My view is that higher inflation will be only temporary — the result of base effects (such as last year’s VAT cut on hospitality dropping out of the numbers) and shortlived localised shortages which market forces should eventually correct. But we must never base our investment strategy upon a forecast alone. We must consider the range of possible outcomes, and high inflation is within this range: to think otherwise is to be overconfident about our forecasting abilities.

Risk is sometimes defined as probability multiplied by impact. Those who worry about significant inflation are, I suspect, mistaken about its probability. They might not, though, be so wrong about its impact.

Chris Dillow is an economics commentator for Investors’ Chronicle



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