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Categorized | Equities

Investors Chronicle: WPP, Plexus, SSE

Posted on November 11, 2016

Buy: WPP (WPP)

WPP intends to earn 40 to 45 per cent of turnover in fast-growing markets and new media over the next four to five years, writes Theron Mohamed. Following the EU referendum, it also plans to deepen its foothold in continental Europe.

Geographical expansion and technology investments underpinned like-for-like net sales growth across all regions and three out of four divisions of WPP in the third quarter to September 30. Despite the Brexit vote, the advertising giant still expects full-year net sales to grow by over 3 per cent, and the constant-currency net sales margin to widen by 0.3 percentage points to 16.8 per cent.

New business grew by 8 per cent to about £3.47bn in the nine months to 30 September. However, acquisitions and share buybacks meant average net debt swelled 12 per cent to £4.21bn. Broker Macquarie expects earnings per share of 114p in 2016, up from 94p in 2015.

The advertising group has warned that a softening in like-for-like revenue growth in the UK, its home market, was “perhaps reflecting the first impact of Brexit uncertainties”.

“It’s tough sledging,” said Sir Martin Sorrell, chief executive, who campaigned for Britain to remain in the EU. “Slow growth is the new normal and we don’t see any reason to think that will change in 2017.”

WPP’s shares are up 13 per cent on our buy tip in March 2015 but still trade at 15 times forecast earnings, undervaluing an industry leader with a stellar record and compelling growth strategy.

Buy: Plexus (POS)

In a very tough market, Plexus’s ability to manage costs is impressive and its decision to suspend its dividend was inevitable, writes Megan Boxall. Cenkos thinks the low point in exploration activity will come next year, and this company will be ready when the cycle turns.

The strong position of wellhead services supplier Plexus on the North Sea continental shelf has caused it some considerable heartache in the past year. With global oil prices falling to a 13-year low in January, exploration drilling activity in the North Sea dropped to the lowest level ever recorded. The subsequent diminished demand for the group’s POS-GRIP wellhead equipment saw the company swing to an adjusted net loss of £5.8m from a £5.4m profit in the prior year.

Responding to the downturn, the group has taken considerable steps to reduce its cost base. In the reported period, almost half of annualised personnel costs and general overheads were stripped out and research and development expenditure dropped from £4.1m to £2m. This has helped protect the balance sheet through the current turbulence.

But the cyclical low point has clearly exposed the group’s narrow geographical exposure and limited number of products. Management is actively searching for new contracts away from the North Sea, and secured two such purchase orders in the reported period. It is also expanding the number of its friction-grip products through collaborations with big drilling companies.

Nevertheless, broker Cenkos expects losses to endure in the year to June 2017 and has forecast a pre-tax loss of £5.9m and a loss per share of 5.6p (losses of £6.2m and 5.6p in full-year 2016).

Hold: SSE (SSE)

One of the biggest challenges for SSE is maintaining its pledge to keep increasing its dividend at least in line with RPI inflation, while preserving adjusted earnings coverage of 1.2-1.4 times over the three years to 2019, writes Emma Powell.

Management says it is on course to achieve this for the full year, but this is still below its longer-term target of close to 1.5 times. The income is good for now.

Energy giant SSE (SSE) is preparing for record annual investment and capital expenditure of around £1.85bn next year. Following its sale of a 16.7 per cent stake in Scotia Gas Networks in October, management has announced plans to direct £100m towards construction of the 225 megawatt Stronelairg wind farm. The remaining proceeds will finance a share buyback of about £500m.

Favourable mark-to-market movements in the group’s forward purchase contracts for power, gas and other commodities boosted reported pre-tax profits. However, a fall in wholesale and retail revenue left adjusted operating profits down 9 per cent at £637m.

The wholesale business suffered a decline in adjusted operating profits of just under a quarter, largely as a result of a 21 per cent decrease in electricity output from renewables. On the retail side, customer account numbers fell from 8.41m to 8.13m. As a result, average household electricity supplied declined to 1,544 kilowatt hours.

The networks business — which includes gas and electricity distribution and electricity transmission — put in a better performance during the period. It reported a marginal uplift in adjusted operating profits to £456m, due primarily to the gas distribution business.

Chris Dillow: Equities after Trump

Shares fell sharply on the day after the UK voted to leave the EU only to recover nicely. Might not we see the same pattern in response to Donald Trump’s victory in the US presidential election? The answer is: yes, but.

The reason to expect a bounce is that uncertainty is bad for stock markets and as uncertainty diminishes shares should recover.

As Mr Trump’s policy agenda becomes clearer, uncertainty should fall, thus raising prices. As the old saying goes, “better the devil you know.”

And Mr Trump might not be the devil. Barclays’ Will Hobbs says: “Little of President Trump’s campaign trail rhetoric will make it to actionable policy.” And Brian Davidson at Fathom Consulting believes we’re more likely to see “Trump lite” than “Donald Dark”. The old clichés about checks and balances and campaigning in poetry but governing in prose are clichés because they are true.

Shares might get further support from monetary policy. Philip Shaw at Investec says “a December Fed hike is less likely” because the Fed would be loath to raise rates at a time of uncertainty.

So much for the good news. There are, however, reasons to worry.

One is that low interest rates won’t last long. Ian Kernohan at Royal London Asset Management says that in the longer run a looser fiscal policy, immigration controls and higher tariffs would all raise inflation and interest rates, which would be bad for bonds.

Also, it’s possible that long-term dividend growth might be lower — something that would justify permanently lower equity prices. Even if Mr Trump cannot implement his more flamboyant campaign rhetoric, tougher immigration controls and some kinds of trade barriers look likely. Both would hurt long-term growth. Mr Shaw says: “There is a tangible risk that a Trump presidency could fuel anti-globalisation momentum and spark a wave of protectionist policies around the globe.” This, he says, “would almost certainly knock not just US, but world growth prospects”.

Yes, a weaker US dollar and easier fiscal policy might well boost growth. These, though, are short-term cyclical positives. The blows to growth from immigration controls and tariff barriers might be longer-lasting — sufficiently so perhaps to offset Mr Trump’s promised cuts in corporation tax.

This is not to say they’ll be catastrophic. Developed economies are resilient to policy shocks, and history tells us there is little governments can do greatly to change long-run growth. Nevertheless, even 0.1 percentage point lower dividend growth should mean a 0.1 percentage point lower dividend yield – which would wipe 4 per cent off prices.

Insofar as Mr Trump’s victory is an assertion of the power of Main Street against “elites”, it calls into question the shareholder-friendly policies investors have enjoyed since the 1980s.

This raises the question: will we see a shift in incomes away from profits towards wages? Here, the signals from Mr Trump have been ambiguous. On the one hand, his calls for corporate tax cuts augur well for investors. But his protectionism doesn’t. Mr Davidson warns that this would be “a disaster for capitalists the world over”.

But there might be something else. Uncertainty of the sort that can be quantified by Mr Bloom and colleagues is only part of the story. Mr Trump’s victory has increased uncertainty in two other ways, which might be longer-lasting.

For one thing, the simple fact that markets weren’t expecting a Trump win — just as they weren’t expecting Brexit — should remind investors that they know less about the future than they think. If this lesson is learned (which given the power and ubiquity of overconfidence it might not be) then risk premia should stay higher than they have been in the past.

Also, Mr Trump’s victory might change outsiders’ perceptions of the US. For decades, the US has enjoyed what Valery Giscard d’Estaing called “exorbitant privilege”: demand for US assets has been higher than the US’s large overseas debt and suspect economic fundamentals would warrant, which has allowed the country to borrow cheaply. In part, this has been because the US has been regarded as a low-ambiguity economy. Thanks in part to the country’s cultural hegemony, foreigners feel a familiarity with it which they don’t feel towards (say) Japan or Germany.

However, Mr Trump’s surprise victory has taught us that we perhaps know less about the US than we think: there’s much more to it than Hollywood and New York, some of which isn’t pretty: it is Beverly Hillbillies more than the West Wing. This poses the danger that the US will lose its exorbitant privilege, its safe haven status and ability to borrow cheaply. This won’t happen overnight, but over years. If Mr Trump’s victory is a watershed moment — and that is for now an if — it is perhaps one in this sense.

Chris Dillow is an economics commentator for Investors Chronicle

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