Markets Now – Thursday 16th July 2020


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You’ll probably have seen that Twitter was root-hacked overnight and literally nothing of consequence happened. Things of consequence might have happened of course — securities fraud setups, blackmail hustles, all sorts — but it seems they didn’t. Instead, a person or persons vandalised a few blue-tick accounts for less than an hour and extracted bitcoin with a dollar value in the upper five to lower six figures, which was probably donated to reward chutzpah rather than out of confusion. As widely noted, it wasn’t a terribly convincing bluff.

Twitter’s down nearly 6 per cent pre-market (having gained 3.8 per cent pre hack) amid a lot of talk about systemic failure, reputational damage and potential legal liability. Alternatively, it’s down on a reminder that nothing on Twitter really matters. It’s a completely self contained signal-to-noise generator that is to the global discourse what Muzak is to music.

Talking of bluffs . . . Remember last April when GVC CEO Kenny Alexander said he was “fully committed” to the company, after selling more than two-thirds of his stake in the bookmaker for £13.7m? Remember in August when he said he’d be staying on “for at least another three years”? Yeah, about that:

GVC Holdings PLC (LSE: GVC), the global sports betting and gaming group, announces that, after 13 years as Chief Executive Officer, Kenneth Alexander is to retire from the Board and from the Company. He will be succeeded by Shay Segev, GVC’s Chief Operating Officer.

The changes, which follow a long-term succession process, will take place at the close of business tomorrow (17 July 2020). Shay will join the Board from 17 July 2020. Kenneth has offered to remain available to Shay and the team as required.

Quitting two years after the strategically questionable Ladbrokes acquisition — which gave GVC cash from regulated markets but tied up a lot of time and money in the moribund UK just as the world was getting excited about the US — looks less than ideal. It’s also the case that with GVC up nearly 50 per cent in a year the mood isn’t right to revive the take-private speculation that does the rounds habitually. What we have, then, is decent numbers versus key man and/or buried bodies risk. Here’s Shore Capital:

Under Mr Alexander’s stewardship GVC has risen from an Aim minnow to one of the leading global gaming groups. His retirement should not distract from what is a pretty stellar update for the six months to June, a period which covers the cancellation of most sporting fixtures and the closure of the majority of its retail outlets.

EBITDA for the six months is expected to be in the range of £340-350m; or c£300-310m excluding IFRS-16. This would not be far off the £323m generated in the corresponding period last year and sharply ahead of our expectations based on earlier guidance for modest monthly EBITDA losses during lockdown.

The better than expected performance in H1 was driven by digital, with online NGR up 19% in the six months and by a knockout 22% in Q2 alone, despite the cancellation of sporting fixtures in the period, and aided by reduced marketing. In Q2, sports NGR was down just 6% (aided by favourable sports margins) and gaming ahead by 45% reflecting the broad geographical and product spread. Post the return of the sporting calendar activity is said to be close to pre-Covid levels, whilst online gaming continues to trade ahead of expectations, albeit below peak levels. Our full year expectations for digital at the turn of the year was for low-double-digit NGR growth so trading during the period was comfortably ahead.

Elsewhere, retail, both in the UK and International, was heavily impacted by shop closures in the period. All stores across England, Italy, Belgium and RoI have now reopened, with early response from customers in England said to be encouraging. It is worth remembering that LFL revenues in UK retail were down just 5% ahead of lockdown, despite the comparative period including the contribution from higher staking limits on FOBTs.

The return of sport and the reopening of retail should be supportive to the second half; although a return of marketing to more normal levels versus the reduction in H1 will likely be a drag. At this stage, we expect a broadly similar outcome in the second half to H1 implying full year EBITDA of c£700m (£620m pre IFRS 16). We would see this as a notable outcome for the year given the backdrop and supportive of further debt reduction in the year.

We wish Mr Alexander well and he leaves with the group in good momentum. Getting on the front foot regarded regulation and delivering on the US sports betting opportunity would be significant catalysts for a re-rating in our view.

And Davy:

While the departure of Kenny Alexander as Group CEO is likely to disappoint shareholders, his successor (Shay Segev) will come as little surprise. It should protect GVC’s current technology and M&A-led approach. Following several sector trading updates (including a short GVC AGM statement as recently as June 24th), its current trading is better understood. Group revenue fell by 22%, with the shuttering of its UK and European Retail businesses (almost 40% of FY19 revenue combined) offset by a stronger-than-expected Online performance (+23%). While the demand environment remains highly uncertain, H1 profit guidance (EBITDA c.£340-350m) should drive a material upgrade to current year estimates (c.£620m). FY21 EBITDA forecasts (c.£850m), back to c.90% of pre-COVID levels, already appear more realistic.

And RBC:

GVC remains the value name to play the structural growth story in the online gambling market – led by the nascent US opportunity. We believe the regulation of the US sports betting & iGaming market will benefit all the major European online gambling operators, as they come with extensive knowhow and – most importantly – the technology to provide the relevant services. GVC aims to build a business of scale globally, which will be backed by its end-to-end proprietary tech platform and consistent track record in growing online net gaming revenue. The group trades at 9.5x FY22e PE, cheaper than peers William Hill at 11x and Flutter at 16x.

Gun-for-hire videogames developer Sumo raised £13.7m overnight at 180p, a 10 per cent discount to its closing price, to “take advantage of potential M&A opportunities that may arise”. Sumo has historically done aqui-hire type deals for small studios of the type we alluded to over the weekend. Jefferies’ Ken Rumph wasn’t a fan:

We note an FT article last week which attempted to draw a parallel between fast fashion/Leicester sweatshops/modern slavery and video games & ‘crunch’ was in our view wholly and dangerously misguided.

Coo! Not just misguided, wholly and dangerously misguided. It was more of a parallel rather than a comparison though, used in the intro to put a news hook on the industry-wide problem of crunch culture and tied specifically to studio M&A risk rather than deployed as a criticism of any listed companies. That’s why, rather than making an offensive and overblown claim that equated games studios to Leicester sweatshops, we used the phrase “a few parallels”. Never mind though, back to Jefferies:

Service providers like Sumo and Keywords specifically avoid the issue almost completely, by their nature – work for hire, outsourcing. ‘Crunch’ is the genuine problem within the industry of developers’ own, generally well-paid, staff working excessive hours as game deadlines near – due to peer pressure, pursuit of promotion, and also and often, a real love of games and desire to make them better. This needs to be managed, and can be exploited, but cannot remotely be compared to sub-minimum wage sweatshop toil. Service providers like Sumo and KWS may sometimes see staff work longer to complete projects, as any professional service provider might, but overall they work on a ‘want more work, pay for more people/time’ model with their customers.

Further reading on how crunch culture isn’t a longstanding problem worth putting on ESG investors’ radars can be found here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here and here, as well as in references 19 through 54 on the Wikipedia page about games developers.

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Fevertree, the tonic water maker that’s not called Fever-Tree, gets a downgrade from JP Morgan Cazenove. Expensive, they say:

 We are downgrading Fevertree Drinks (FEVR) from Neutral to Underweight. Following significant outperformance ytd (+13% ytd; +>150% from mid-March lows vs sector -17% ytd; +28% from lows), the shares are now back at 18-month valuation highs (44x 2021e P/E vs sector 21x) despite lingering COVID-19 pressures to top-line and margins. With little incremental from the H1 2020 pre-close trading update (reaction), risks still look prevalent to more profitable on-trade demand from COVID-19 (c45% of sales), including re-closures in parts of the US. Current valuation skews risk/reward to the downside as it appears to price in a seamless recovery in FY21, including continued share/distribution gains in the US and Europe over the mid-term (despite existing signs of UK share losses). We increase our PT to £19.00 (from £12.60) reflecting a 70% 2021 P/E premium to the sector in-line with its MT top-line outperformance.

 H1 2020 preview. Due to incremental gross margin pressures from country/channel mix our 2020E EPS comes down by c5% with the outer years unchanged due to M&A. For H1 2020 results (to be reported on 8 September), we expect a 24% organic sales decline to £90m (UK -35%, US +10%, Continental Europe -30%, RoW 0%), EBITDA down -34% to £24.2m and adj EPS -36% to 16p. For 2020, we model -9.5% LFL sales to £241m (UK -16.5%, US +13%, Continental Europe -16%, RoW +10%), EBITDA -22% to £59.7m and adj EPS -23% to 39p. At this point, we model 22.5% organic sales recovery in 2021, +38% EBITDA to £82.6m and adj EPS +39% to 54p (in line with 2018). The German GDP acquisition also contributes c£9m 3rd party sales, albeit at a lower margin and growth outlook.

 Snags with the Nielsen strengths. We recognise the positive off-trade sales momentum as seen in Nielsen tracked channels (Europe, USA). However, outside the US (+90% in 12 weeks to 13 June), FEVR is likely to still see yoy declines from subdued on-trade and destocking. Within GB, while the headline 34% yoy sales growth in the 12 weeks to 16 June is impressive vs total carbonates +15%, in fact FEVR is seemingly continuing to lose share within mixers with other key brands +46% (lead by main rival Schweppes). While FEVR momentum in Continental Europe Nielsen is building (+62% yoy in 12 weeks vs peers +17%), it is not enough to offset on-trade losses (45% of sales). There remains distribution upside potential in most of FEVR’s key markets (UK 75%; US c53% (DATA DRIVEN deep dive); France, Germany, Spain c43%; Italy 28%) in the long term; however, we note this is more than priced in at current levels.

BP and Repsol are onto Jefferies’ “buy” list in a sector review:

Oil market fundamentals remain precarious but OPEC+ discipline and US declines should be supportive, and we raise our 2H Brent forecast to $43/bbl. We upgrade BP and REP to Buy and reinstate FP at Buy. Dividend risks are not off the table, but we believe valuation is supportive with the sector FCF yield at 8.3% on our 2021 estimates.

Balanced on the precipice. Oil market fundamentals remain precarious and in the near term we believe that oil price risk is skewed to the downside by COVID-19 demand risks and OPEC+ easing production cuts. Very high inventories and spare capacity approaching 11 mbd makes it unlikely that Brent can hold above $50/bbl until the latter half of 2021. However, OPEC+ has stared into the abyss of sub-$30 Brent, and we expect the group will take incremental oil off the market if prices move below $40/bbl. We also expect US production declines to continue given low activity levels and estimate that the exit rate of US liquids production in 2020 will be 2.8 mbd lower than 2019. We are thus raising our 2H20 Brent forecast to $43/bbl from $37/ bbl despite the near-term price risks. Our 2020/21 estimates are unchanged.

Risk on liquidity, if not dividends, lifted. The macro environment remains difficult but a prolonged period of sub-$30 Brent now seems unlikely. This does not mean that dividend risk is off the table, although liquidity risk likely is. The sector raised $80b in the capital markets in 2Q, and we update our proprietary company-specific liquidity analysis to reflect higher cash positions. Average net debt/capitalization will reach 27% at the end of the year, and the trade-off between dividends and balance sheet strength comes into focus. We are not including any dividend cuts in our forecasts, but we think there is a good chance that BP and ENI do cut; with BP, ENI and REP all yielding >10% we believe the market expects a cut.

Upgrade BP and REP. We have updated our price targets across the sector to now reflect a Brent price of $45/bbl in our terminal value calculations. We upgrade BP and REP to Buy and reinstate FP at Buy on valuation. On BP, this is the first time our team has ever upgraded a stock to Buy when the risk of an imminent dividend cut was possible, but we believe a cut of 65% is already priced into the stock. REP is the only company we expect to be cash generative this year, partially due to a ‘prefunded’ scrip dividend; we believe the 13% dividend yield is safe in the near term. FP, our top pick in Europe, has generated the most consistent results in the sector, and the FCF yield of 10.4% on our 2021 estimates provides strong coverage of the 7.8% dividend yield.

Messy 2Q. Our team has forecasted earnings for 72 quarters and 2Q20 seems the most difficult of them. Not only were price and margins depressed they were volatile which could mean big variances in realized prices depending on when a cargo was lifted in upstream, and negative inventory valuation swings in downstream. Upstream volumes were impacted by curtailments and OPEC+ production cuts, while downstream product sales and refinery utilization collapsed at the beginning of the quarter before recovering to still-low levels by the end.

And Panmure Gordon’s Sanjay Jha has a brave, well argued “buy” upgrade on Rolls-Royce:

We note that management “is looking at options to strengthen its balance sheet and position itself for the recovery”. If the options do not include a meaningful change in corporate strategy, then we have little to recommend to equity investors. Management can and must address the fundamental problem: the asymmetric Civil Aerospace business model which barely covers the cost of capital in incident-free years but amasses heavy losses quickly. However, we believe the share price is already discounting a heavy cost (c£5.2bn) of exiting Civil activities. Our sum-of-the-parts model, which assumes that Civil Aerospace could be divested at a much smaller cost of £2.5bn, values the shares at 400p (previous TP 387p, based on a DCF model). Hence, we are upgrading our recommendation to BUY (from HOLD).

Playing by competitors’ rules: Most of the value in the Civil Aviation boom has been captured by consumers as seemingly unlimited state subsidies worldwide have encouraged a race to the bottom. If Rolls-Royce has destroyed more value than its peers, it is largely because it has had to play by their rules. Today, its primary peers – GE, Safran and Pratt & Whitney (part of Raytheon Technologies) – still enjoy much stronger balance sheets and are more diversified.

 Exit Civil: Even if we dismiss COVID-19, which caused a £3bn cash outflow in H1/20, as an outlier, the fact remains that in the 2016-19 period, Civil Aerospace accounted for 80% and 58% of group capex and R&D respectively, but generated just 20% (£770m) of the underlying profits. However, the true scale of value destruction only becomes apparent when one adds the £2.4bn exceptional cost of dealing with Trent1000 blades. RR lacks the differentiation to charge a premium so unless GE changes its pricing, it risks further value destruction. It should look to divest the business to P&W, which currently has no offering in the widebody market.

 Sum-of-the-Parts Valuation: we have previously used a DCF model to generate a fair value. Given the huge impact on cashflow due to COVID-19 and prospects for balance sheet restructuring, we are now adopting a sum-of-the-parts model. We value the Defence and Power Systems businesses at 11x and 9x 2019 EBITDA. Based on this, we believe that the market is currently assuming Civil Aerospace has a negative value of c.£5.2bn. We believe that this business can be transferred for nil value leaving RR with outstanding liabilities of £2.5bn. This generates a SOTP value per share of 400p.

• Updates follow, influenced or otherwise by requests and complaints in the comment box. A number of AV Telegram group chats are also available.

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