Leading shares have slipped lower after four days of rises, with mining shares and Royal Mail weighing on the index.
But Severn Trent is bucking the trend, up 32p at £20.55 after HSBC moved its recommendation from underweight to neutral and its price target from £18.90 to £20.80. The bank suggested that bids for the remaining water companies could not be ruled out and said:
Severn Trent offers the highest regulatory capital value growth of 10% to 2020 compared to listed peers. We believe the new chief executive, Liv Garfield, will be able to deliver operational improvements in order to allow Severn Trent to achieve a return on regulatory equity at the upper end of the range of +3.35% to -4.85% over or below the base of 5.85%.
Given the lower-return environment of the regulated business, we assume that Severn Trent (with a new treasurer in place) might want to strengthen its balance sheet, in line with utility peers SSE, and National Grid, who issued hybrid debt. In such a scenario, there would be dilution to earnings. We have said in our reports on SSE and Grid, at the time when both issued hybrid debt that these instruments are applicable if there is a need for accelerated investment
The dilution of its dividend cover from a hybrid coupon may not obviate a dividend cut (we continue to assume a 15% rebasing) but would underpin its credit metrics.
Many investors have said to us they believe that, post the final [regulatory] determinations in December, there might be offers for the remaining listed water stocks (seven have been taken private out of ten). The last three bids were at around 30% enterprise value/regulatory capital value premium. On our estimates, the takeout premium of recent deals would imply a valuation around 2,450p for Severn Trent.
Overall the FTSE 100 is down 9.07 points at 6700.06, with mining shares hit by the continuing fall in iron ore prices on worries about Chinese economic growth. Rio Tinto is down 51p at £29.53 while Anglo American has lost 18.5p to 1344.5p and BHP Billiton has fallen 23.5p to 1636.5p.
Royal Mail has dropped 39.2p to 430p on worries about growing competition in the wake of its results.
Intertek is another big faller, down 185p to £24.68 after the testing equipment specialist suggested there would be no improvement in full year organic revenue or operating margin compared to last year.
It said organic revenues fell 0.7% in the ten months to the end of October, with overall revenue down 5.1% after the strength of sterling hit the figures. Analysts at Berenberg said:
We believe these are a weak set of numbers and the comments regarding margin look worrying to us. We expect consensus estimates to come down by 3%-4% on the back of the statement.
Whitbread was caught in a two way pull as HSBC raised its target price from £47 to £50 with an overweight rating.
But UBS repeated its sell rating and cut its target from £42 to £40. UBS analyst Chris Stevens said:
We believe Whitbread is priced for perfection. The shares are trading near all-time highs and the PE multiple has continued to re-rate through the cycle, despite getting ever closer to peak earnings.
We believe ‘perfection’ will be difficult to achieve with comparisons getting significantly tougher in the fourth quarter, and the Premier Inn/Costa opening targets continuing to look at risk, in our view. If earnings momentum slows, we expect to see a significant de-rating. We also have some concerns around the future growth drivers post 2018. While we believe Whitbread is one of the highest quality companies in the leisure sector, the rich valuation leads us to reiterate our sell rating.
But at the moment Whitbread is 9p higher at £44.66.
