Broker tips: UK stocks, Synthomer, THG

(Sharecast News) - Citi has downgraded its average rating for UK stocks to 'underweight', saying the region's heavy exposure to oil could lead to a raft of earnings downgrades in the near future. "The UK economy is approaching an inflection point, with tailwinds from supportive fiscal policy and better-than-expected trade outturns running their course," said analyst Beata Manthey. "Headwinds associated with tighter monetary policy are now building momentum, with unemployment increasing."

Manthey said that a recession was on the horizon for the first quarter of 2024, while the Bank of England will likely begin to loosen monetary policy in mid-2024. Earnings across the UK were "under pressure" in 2023 after a strong 2022, with the fall in oil prices in the first half acting as a key headwind.

Overall, analysts on average expect earnings per share across UK-listed stocks to fall by 6% this year, before bouncing back 5% next year. However, while the consensus for oil prices is around $85 a barrel - similar to current levels - Citi themselves expect a drop to around $70.

"This poses a risk of EPS downgrades. We also worry that the UK's 50% defensive exposure could weigh on performance. We therefore downgrade to 'underweight', Citi's analyst said. "We do however like UK miners given discount valuations and potential upside from China."

Analysts at Berenberg upped their target price on chemicals firm Synthomer from 115.0p to 400.0p on Friday, stating the group's balance sheet had now been "repaired".

Berenberg said Synthomer's current situation reminded it of the predicament faced by the company in late 2008 and early 2009 as cyclical headwinds and "elevated, although not extreme" leverage left shares plunging to lows similar to today's level, falling by over 90% from Covid-19 pandemic highs.

The German bank, which reiterated its 'buy' rating on the stock, highlighted that Synthomer was "a classic early cycle share". However, it also pointed out that shares "more than quadrupled" in the subsequent two years following early 2009.

As far as Berenberg is concerned, the fully-underwritten £276.0m rights issue announced on 7 September has taken the sting out of the worst-case scenario, and the bank said that while it was early to upgrade, the attractions of a2025 price-to-earnings ratio of just 6.0x and 15% free cash flow yield on a de-risked balance sheet were "plain to see".

"The just over 10% average reductions to operating profit mainly reflect lower assumed nitrile latex margins and weaker volume outlook in 2024 for the construction-and-coatings linked component of sales. Our earnings per share changes are less meaningful, as the company has run a 20-1 for stock consolidation stock prior to the 6-1 rights issue," said Berenberg.

Bank of America Merrill Lynch reiterated its 'buy' rating and 125.0p target price on THG on Friday as it argued that margins were now improving and that it was now time for growth.

The US bank said THG's first-half results delivered improved profitability, with adjusted underlying earnings up 45% year-on-year at £47.0m and at the top of the pre-released range, although they disappointed on revenue growth.

"As a result, management reiterated their adjusted EBITDA and neutral free cash flow guidance but cut FY23 growth expectations to flat to -5% (from low-single-digit positive), sending shares down 20% on the day and de-rating circa 25% on FY24 EV/EBITDA since the print."

Bank of America said it views the current 6.3x FY24 EBITDA - around 25% below their 2022 12-month forward average - as an attractive entry point "as the margin and cash flow improvement stories are playing out as intended". It also said FY23 targets look achievable, as does a return to growth in 4Q23 and 2024.

"While the revenue decline in 1H23 was greater than expected - especially in the Beauty division - the worst now appears to be behind us," Merrill said. "In the UK, the two largest headwinds - falling online penetration and low consumer purchasing power - began to show signs of improvement for the first time since 2021 this summer. Management called out positive growth in Beauty starting in August, and we expect group level growth to turn positive again in 4Q23 as Beauty improves with manufacturing revenue picking up again."

BofA, which said it saw reasons for optimism in all three divisions, said that in addition to a return to positive growth in August, the beauty division should see improved margins in 2H23 as the margin-accretive manufacturing business ramps back up following industry-wide de-stocking throughout much of 2022 and 2023. It also noted that the adjusted EBITDA margin in the nutrition segment rose 560 basis points to 13.8% in 1H23 thanks to falling whey prices.