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US bank earnings quick take: BoA losing interest – Comment
Interest rates seem to be the emerging story of this quarter’s bank earnings. Q2 was all about trading income and loan loss provisions; Q3 is all about the collapse in net interest income.
It should come as no surprise that US banks are struggling with ultra-low rates, but there has been a significant drop in the core earning capacity of banks this quarter that cannot be masked by strong trading revenues.
Bank of America beat on the bottom line but missed on the top. Net income came in at $4.9 billion, or $0.51 per diluted share, which was a little ahead of the $0.49 expected and down 16% on the year. Provision for credit losses increased to $1.4 billion, driven by COVID-19 impacts in commercial lending.
BoA is very sensitive to rates and shares in pre-market trading did not take well to the decline in rates income, with BAC -1.6% after its 2.84% decline yesterday. Net interest income (NII) was down $2.1bn, or 17%, to $10.1 billion, driven by lower interest rates.
This comes after JPM reported –9% yesterday and it is a material increase in the pace of the decline from the –11% posted in Q2. This sensitivity is explained by the fact that loans were up 5% to $319 billion; while JPM saw lending decrease, which would lower its exposure to interest rates. In the consumer bank, net income declined $1.3 billion to $2.1 billion, while revenues of $8.0 billion were -17% lower, driven by lower NII from lower rates.
Noninterest income was also lower, declining by 4% to $10.2bn, reflecting a drop in fee income which was offset by better trading and investment banking results. That said, trading revenues weren’t spectacular – FICC +3% and equities +6%, which was not as strong as peers.
Return on equity improved. In Q2 return on equity (ROE) fell to 5.44% from 5.91% in the prior quarter and was down significantly from last year’s Q2 11.62%. Return on tangible equity (ROTE) slipped to 7.63% from 8.32% in Q1 2020 and from 16.24% in Q2 2019. In Q3, ROE rose to 7.24%, while ROTE rose to 10.16%.
Banks set to kick off US Q3 earnings season
The S&P 500 rose 8.5% to 3,363 over the third quarter, having hit an all-time of 3580 at the start of September, with an intraday peak at 3588. The market faced ongoing headwinds from the pandemic, but risk sentiment remained well supported through the quarter by fiscal and monetary policy.
A pullback in September erased the August rally but was largely seen as a necessary correction after an over-exuberant period of speculation and ‘hot’ money into a narrow range of stocks.
Q3 earnings come at important crossroads: Expectations for when any stimulus package will be agreed – and how big it should be – continue to drive a lot of the near-term price action, though the market has largely held its 3200-3400 range.
Elevated volatility is also expected around the Nov 3rd election. But next week we turn to earnings and the more mundane assessment of whether companies are actually making any money.
Banks kick off Q3 earnings season
Financials are in focus first: Citigroup and JPMorgan kick off the season formally on October 13th with Bank of America, Goldman Sachs and Wells Fargo on the 14th. Morgan Stanley reports on Oct 15th, In Q2, the big banks reported broadly similar trends with big increases in loan loss provisions offset by some stunning trading earnings.
Wall Street beasts – JPM, Goldman Sachs, Citi, Morgan Stanley and Bank of America – posted near-record trading revenues in the second quarter with revenues for the five combined topping $33bn, the best in a decade. At the time, we argued that investors need to ask whether the exceptional trading revenues are all that sustainable, and whether there needs to be a much larger increase for bad debt provisions.
Meanwhile, whilst the broad economic outlook has not deteriorated over the quarter, it has become clear that the recovery will be slower than it first appeared. Moreover, during Q3 the Fed announced a shift to average inflation targeting that implies interest rates will be on the floor for many years to come, so there is little prospect of any relief for compressed net interest margins.
Meanwhile there is growing evidence of a real problem in the commercial mortgage-backed securities (CMBS) market as new appraisals are seeing large swatches of real estate being marked down, particularly in the hotels and retail sectors.
At the same time, the energy sector has gone through a significant restructuring as we have seen North American oil and gas chapter 11 filings gathering pace through the summer as energy prices remained low. There is a tonne of debt maturing next year but how much will be repaid?
Key questions for the banks
- Did the jump in trading revenues in Q2 carry through in Q3? Jamie Dimon thought it would halve.
- On a related note, did the options frenzy in August help any bank more than others – Morgan Stanley?
- Have provisions for bad loans increased materially over the quarter?
- How bad are credit card, home and business loans?
- And how bad is the commercial property sector, especially hotels and retail as evidence from the CMBS market starts to look very rocky?
- How are bad debts in oil & gas looking?
- How are job cuts helping Citigroup lower costs; how will its entry into China make a difference to the outlook?
- How does Wells Fargo manage without an investment arm to lean on? So far it’s been a bit of a mess.
- Was Warren Buffett right to cut his stake in Wells Fargo and some other US banks? Buffett pulled out airlines first then banks.
- What do banks think of never-ending ZIRP and does the Fed’s shift affect forecasts at all?
- How is Morgan Stanley’s wealth management division cushioning any drop in trading revenues?
- What progress on Citigroup’s risk management system troubles?
Q2 earnings recap
JPMorgan beat on the top and bottom line. Revenues topped $33.8bn vs the $30.5bn expected, whilst earnings per share hit $1.38 vs $1.01 expected. The range of estimates was vast, so the consensus numbers were always going to be a little out.
The bank earned $4.7bn of net income in the second quarter despite building $8.9 billion of credit reserves thanks to its highest-ever quarterly revenue. Loan loss provisions were $10.5bn, which was more than expected and the quarter included almost $9bn in reserve builds largely due to Covid-19.
The consumer bank reported a net loss of $176 million, compared with net income of $4.2 billion in the prior year, predominantly driven by reserve builds. Net revenue was $12.2 billion, down 9%. Credit card sales were 23% lower, with average loans down 7%, while deposits rose 20% as consumers deleveraged.
The provision for credit losses in the consumer bank was $5.8 billion, up $4.7 billion from the prior year driven by reserve builds, chiefly in credit cards.
Trading revenues were phenomenal, rising 80% with fixed income revenues doubling. Return on equity (ROE) rose to 7% from 4% in Q1 but was still well down on the 16% a year before. ROTE rose to 9% from 5% in the prior quarter but was down from 20% a year before.
Citigroup EPS beat at $0.50 vs the $0.28 expected. Trading revenues in fixed income rose 68%, and made up the majority of the $6.9bn in Markets and Securities Services revenues, which rose 48%. Equity trading revenue dipped 3% to $770 million. Consumer banking revenues fell 10% to $7.34 billion, while net credit losses, jumped 12% year over year to $2.2 billion. Net income was down 73% year-on-year.
Since then the bank has offloaded its retail options market making business, leaving Morgan Stanley (reporting Oct 15th) as the major player left in this market. We await to see what kind of impact the explosion in options trading witnessed over the summer had on both. ROE stood at just 2.4% and ROTE at 2.9%.
Wells Fargo – which does not have the investment banking arm to lean on – increased credit loss provisions in the quarter to $9.5bn from $4bn in Q1, vs expectations of about $5bn. WFG reported a $2.4 billion loss for the quarter as revenues fell 17.6% year-on-year.
CEO Charlie Scharf was not mincing his words: “We are extremely disappointed in both our second quarter results and our intent to reduce our dividend. Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter, which drove the $8.4 billion addition to our credit loss reserve in the second quarter.”
Bank of America reported earnings of $3.5 billion, with EPS of $0.37 ahead of the $0.27 expected on revenues of $22bn. Its bond trading revenue rose 50% to $3.2 billion, whilst equities trading revenue climbed 7% to $1.2 billion. But the bank increased reserves for credit losses by $4 billion and suffered an 11% decline in interest income.
Return on equity (ROE) fell to 5.44% from 5.91% in the prior quarter and was down significantly from last year’s Q2 11.62%. Return on tangible equity (ROTE) slipped to 7.63% from 8.32% in Q1 2020 and from 16.24% in Q2 2019.
Morgan Stanley was probably the winner from Q2 as it reported net revenues of $13.4 billion for the second quarter compared with $10.2 billion a year ago. Net income hit $3.2 billion, or $1.96 per diluted share, compared with net income of $2.2 billion, or $1.23, for the same period a year ago.
Wealth Management delivered a pre-tax income of $1.1 billion with a pre-tax margin of 24.4%. Investment banking rose 39%, with Sales and Trading revenues up 68%. MS managed to increase its ROE to 15.7%, and the ROTE to 17.8% from respectively 11.2% and 12.8% in Q2 2019.
Goldman Sachs reported net revenues of $13.30 billion and net earnings of $2.42 billion for the second quarter. EPS of $6.26 destroyed estimates for $3.78. Bond trading revenue rose by almost 150% to $4.24 billion, whilst equities trading revenue was up 46% to $2.94 billion. ROE came in at 11.1% and ROTE at 11.8%.
|Bank||Forecast Revenues (no of estimates)
|Forecast EPS (no of estimates)
|BOA||$20.8bn (8)||$0.5 (23)|
|GS||$9.1bn (15)||$5 (21)|
|WFG||$17.9bn (17)||$0.4 (24)|
|JPM||$28bn (19)||$2.1 (23)|
|MS||$10.4bn (15)||$1.2 (20)|
|C||$18.5bn (17)||$2 (21)|
None have really managed to match the recovery in the broad market but valuations are compelling.
Goldman trading either side of 200-day EMA
Wells Fargo can’t catch any bid
Bank of America bound by 50-day SMA
Citigroup still nursing losses after reversal in September
JPM breakouts consistently fail to hold above 200-day EMA
Cineworld shares collapse: who is next?
Cineworld shares collapsed on Monday after the company closed its UK and US theatres after the latest James Bond picture was delayed. Shares dived around 44% to trade at 22p.
Lumbered with over $8bn in debt and with a $1.6bn loss in the first half, things were looking dicey for Cineworld well before today’s update. Short interest in the stock was exceptionally high as hedge funds circled a vulnerable member of the herd.
Looking at Shorttracker.co.uk we can see the following stocks are the top targets by short sellers.
|Company||% short||Funds short|
|PREMIER OIL PLC||8.10%||2|
|TULLOW OIL PLC||7.90%||5|
|METRO BANK PLC||7.80%||5|
|SAINSBURY (J) PLC||6.50%||4|
|INTL CONSOLIDATED AIRLINE-DI||5.90%||7|
|BABCOCK INTL GROUP PLC||5.80%||4|
|WEIR GROUP PLC/THE||5.40%||5|
|BLUE PRISM GROUP PLC||4.70%||5|
|VODAFONE GROUP PLC||4.40%||4|
|DOMINO’S PIZZA GROUP PLC||4.00%||6|
|WOOD GROUP (JOHN) PLC||4.00%||6|
|MICRO FOCUS INTERNATIONAL||3.80%||3|
|N. Brown Group||3.80%||3|
|WM MORRISON SUPERMARKETS||3.70%||3|
|ASHMORE GROUP PLC||3.50%||4|
It’s not always the best indicator but the Altman Z-Score is always worth looking at. Here’s the lowest scoring stocks on the FTSE 350. (source: Reuters)
|FTSE 350 Index||.FTLC||—|
|Vodafone Group PLC||VOD.L||-0.43|
|London Stock Exchange Group PLC||LSE.L||0.03|
|IntegraFin Holdings plc||IHPI.L||0.08|
|TP ICAP PLC||TCAPI.L||0.16|
|Ninety One PLC||N91.L||0.23|
|Rolls-Royce Holdings PLC||RR.L||0.62|
|Premier Foods PLC||PFD.L||0.62|
|Aston Martin Lagonda Global Holdings PLC||AML.L||0.65|
|Intermediate Capital Group PLC||ICP.L||0.73|
|Airtel Africa PLC||AAF.L||0.77|
|Severn Trent PLC||SVT.L||0.77|
|United Utilities Group PLC||UU.L||0.85|
|Cineworld Group PLC||CINE.L||1.08|
|Pennon Group PLC||PNN.L||1.09|
|National Grid PLC||NG.L||1.11|
|Diversified Gas & Oil PLC||DGOC.L||1.15|
|Mitchells & Butlers PLC||MAB.L||1.18|
|Talktalk Telecom Group PLC||TALK.L||1.18|
|British Land Company PLC||BLND.L||1.21|
|BT Group PLC||BT.L||1.23|
|National Express Group PLC||NEX.L||1.24|
|Signature Aviation PLC||SIGSI.L||1.25|
Traders can make up their own minds about which companies may require additional capital raising using the Reuters equity analysis tool in the platform.
Europe’s best performing stocks in Q3
Although the coronavirus pandemic is still hanging over the stock market, Q3 saw attention turning to the recovery prospects after the damage dealt in the first half of the year.
Here are some of the best and worst performers in the quarter just ended.
M&A activity picks up
Covid-19 slammed the brakes on M&As during the first half, with the value of deals conducted dropping -64% on the year during Q2. Things have rebounded sharply in Q3, with deals down only -8.4%.
G4S registered the best performance of all Stoxx 600 shares in Q3, with the stock up 76% largely thanks to an approach from Canada’s GardaWorld.
A $9.2 billion deal to buy Ebay’s classifieds business help push the stock of Norway’s Adevinta up 65%.
Suez also got a boost from M&A after Veolia Environment offered take a 29.9% stake in the company in the first step towards a full takeover.
EU green plan boosts renewable stocks
ESG (environment, social, and governance) investing helped stocks with an environmental focus race ahead of the wider market in Q3.
Lockdowns create home improvement boom
The reality of being stuck at home for a long time, or needing to prepare a space for homeworking, has fuelled a DIY boom that made Kingfisher and Kesko two of the top 20 performing European stocks in Q3.
The UK’s Kingfisher hit a level not seen in over two years, while Finland’s Kesko came close to notching a new record high.
Gold miners flourish as safe-haven demand persists
Safe-haven demand, and a bet that vast central bank and government stimulus measures will eventually spark strong inflation, continued to support gold in Q3. Fresnillo was the best-performing gold miner, followed by Centamin and Polymetal.
Healthcare stocks were some of the worst performers in Q3, despite having surged in the first half of the year. The impact of the pandemic upon elective procedures saw Ambu trim its outlook and deliver some of the sector’s worst returns. Meanwhile, Galapagos tumbled over -30% after its rheumatoid arthritis treatment failed to get approval from the US Food and Drug Administration.
Uber shares spike on London green light
Shares in Uber rose 6% to over $36 in pre-market trading after the company secured its right to operate in London for another 18 months. This is an important victory for the company and removes a significant regulatory overhang, but the pandemic continues to exert an enormous drag on earnings and present management with a significant headache over the business model.
We should also note that this is not a permanent pass – the mayor of London indicated that Uber would face continuous scrutiny, whilst the company faces ongoing competition in the capital from the likes of India’s Ola and Estonia’s Bolt. But the decision today unquestionably is a good news story for Uber as it tries to stop its cash burn.
London was and, thankfully for investors, still is a big deal for Uber – with about 3.5m users, it was the largest market in Europe for the ride-hailing app. London has been dubbed one of the group’s ‘fab five’ cities – along with New York, San Francisco, Los Angeles and Sau Paulo – which account for around a quarter of global revenues. Or at least, they did before the pandemic wrought havoc with the business model.
Rides down, Delivery up
Gross bookings at the core Rides division (now called Mobility) were down by three-quarters in the second quarter as the people stayed home, offices remained shut and lockdowns in several locations remained in place.
But while we are travelling a lot less, we are ordering in a lot more: Eats (now dubbed Delivery) rose 113%. Mobility revenue declined 67% year-over-year and Delivery revenue grew 103% year-over-year.
The group’s net loss was $1.8bn for the quarter on revenues that were down 27% on a constant currency basis to $2.2bn – the resilience of Delivery/Eats is not enough to stop the ongoing cash burn. Indeed, excluding stock-based compensation costs, the net loss rose by a fifth when compared with last year.
Cash on hand fell under $8bn which is about what it burned through last year alone.
Plans to offload its stake in China’s Didi may help raise cash but this will only go some of the way to mitigating the shift in bookings to Delivery from Mobility. Weakness in the latter division is likely to exert ongoing pressure on earnings.
Uber still facing regulatory challenges
Moreover, whilst Uber seems to be riding out the pandemic thanks to being able to do home deliveries, regulatory overhang remains. The list of legal issues either historic or ongoing is long and broad both in scope and geography.
For instance, in California and in Britain it is fighting lawsuits that would force the company to treat drivers as employees. These present ongoing overhang for the stock as, whilst there have been problems about corporate culture and vetting of drivers, by and large the run-ins with the regulators and policymakers pertain to the very structure of the business itself and how it operates; taxation, labour laws and consumer safety are the milking stool of regulatory instability.
As noted almost a year ago, from Chicago to Los Angeles, New York to San Francisco, there have been all kinds of legal roadblocks in the way. Some are resolved, some not. City authorities have been alarmed at the rise of Uber and have pursued a range of legal and regulatory avenues to stymie the company.
Already in a number of key markets, including Argentina, Germany, Italy, Japan, South Korea, and Spain, the company’s ridesharing business model has been blocked, capped, or suspended, or Uber has been required to change its business model.
Ultimately, Uber can probably navigate regulatory minefields without losing all its limbs, but the pandemic makes a positive free cash quarter look even further away. How long are investors prepared to wait?
Futures drop on US Jobless claims
Long and slow: the road to recovery is a winding one. US initial jobless claims rose to 870k last week, indicating ongoing weakness in the labour market as the country struggles out of recession. This was a small increase on the week before and was ahead of market expectations.
Continuing claims declined only a fraction, to 12.58m. The previous week’s level was revised up 119,000 from 12,628,000 to 12,747,000. Unemployment fell marginally to 8.6% after the previous week’s number was revised up to 8.7%.
On a more encouraging note, the total number of people claiming benefits in all programs for the week ending September 5th was 26,044,952, a decrease of 3,723,513 from the previous week.
Nevertheless, the more recent rise in initial claims is a worry that the momentum in the labour market has faded, which would chime with the kind of warnings that Fed officials have been laying on thick this week.
Futures dropped sharply with the Dow called down ~120 pts around 26,640 and the S&P 500 down ~20pts around 3,214 which would take out the week’s low at 3,229, a two-month trough that sits neatly on the 10% correction level from the recent all-time intra-day high at 3,588. Immediate support emerged at 3212.
Sentiment appears very weak with the downside bias in favour. With economic indicators failing to deliver lift-off and stimulus apparently off the table before the election, there needs to be a positive catalyst to get the bulls back in the game.
Otherwise with election risks and a worsening outlook for the recovery, we need to consider further losses as we approach the election.
Palantir IPO: Direct listing moved to September 29th
One of the most hotly-anticipated public offerings of the year is happening next week. Palantir, the secretive data analytics company backed by PayPal co-founder Peter Thiel, will list on the NYSE under the symbol PLTR via a direct listing on September 29th.
The company originally planned to go public on September 23rd, but recently changed the date. Registered stockholders are expecting to sell up to 257 million Class A shares.
During 2020 Q3 around 36 million shares were sold privately at a volume-weighted average of $6.45. So far this year the company has privately raised $900 million at $4.65 per share. The company’s estimated value is between $18 billion and $26 billion.
Spotify and Slack are the only two other tech companies in recent years to have gone public via a direct listing. Palantir is using the same bank – Citadel Securities – that worked with them to help advise it during the process.
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Tesla Battery Day primer: Can Musk deliver as TSLA rallies on event hype?
Tesla Battery Day primer
- Battery Day event scheduled for Sep 22nd
- Signs of speculative buying ahead of event
- Elon Musk hints at more energy dense batteries
Investors are charged up with excitement ahead of Tesla’s Battery Day event. Shares have rallied about 25% in the last week after the stock tapped on the 50-day simple moving average following some heavy selling in the middle of the Nasdaq’s early September pullback.
This of course followed disappointment at missing out on S&P 500 inclusion, and some very aggressive bid that took place in and around the stock split. So is Battery Day all hype, or is there something to it?
Tesla’s 2020 annual meeting of stockholders will be held on Tuesday, September 22, 2020, at 13:30 Pacific Time. Immediately after this meeting, Tesla will hold the Battery Day event.
CEO Elon Musk, in his usual caution, said in January that the event will ‘blow your mind’. Recently he toned it down a bit, teasing ‘many exciting things’. Whilst we should always take his pronouncements on Twitter with a pinch of salt, clearly there is a high degree of expectation and speculation – and speculative buying of TSLA stock – taking place in the run-up to the event.
To deliver on its EV promise, Tesla needs to own the battery space. Without this, it’s not so different to an OEM. Musk commented on this at Tesla’s Q4 2019 earnings call in January, explaining that in order to ramp up Model Y production, introduce the Cybertruck and launch the Semi electric truck, a lot more batteries would be needed.
“So, the thing we’re going to be really focused on is increasing battery production capacity because that’s very fundamental because if you don’t improve battery production capacity, then you end up just shifting unit volume from one product to another and you haven’t actually produced more electric vehicles,” Musk said.
And whilst Tesla has a lead in the powertrain stakes, traditional players may catch up. “It’s worth noting that the Model S has like a 100 kWh pack, the [Porsche] Taycan has like a 95 kWh pack. The Model S is steadily approaching 400 miles of range. The Taycan has 200 miles of range. So we must be using that energy pretty efficiently, and the powertrain is a big part of that,” Musk added in January.
Whilst battery production is one thing, making the batteries more efficient is quite something else. Tesla’s acquisition of Maxwell, an ultra-capacitor manufacturer and battery technology business based in San Diego, is a considerable factor.
What to expect from Tesla’s Battery Day
My expectation is that Musk is about to announce if not a leap then a progression in battery technology that brings EV costs down to, or close to, traditional automobiles. It would be a surprise if Tesla were not able to say it has made further progress on batteries that are more energy dense and have a longer life.
We note for example, that on August 24th this year Musk said battery cells of 400 Watt hours per kilogram (Wh/kg) with a high cycle would be possible in volume within 3 to 4 years, way beyond the current 260 Wh/kg in the Model 3, which could indicate knowledge of some improvement coming in the Tesla batteries.
There has also been speculation that Tesla may unveil “silicon nanowire anode” technology that can greatly increase battery density and cell life. All of this remains speculation, of course.
If Tesla can both lower costs and increase battery energy density and life, it would be a significant step forward for the company and further cement its lead in the EV space. However, given the recent rampant speculation on the stock and Musk’s capacity to somewhat overstate his case, there is a considerable risk of a buy-the-rumour, sell-the-fact trade.
Tesla Stock Signals
Whilst client flows remain positive (87% bullish), analysts remain downbeat – the average price target of $300 vs the current $450 for the stock implies a 34% downside. We also note that hedge funds have been decreasing their holdings.
Baillie Gifford, one of the top shareholders, recently reduced its stake as the holding approached fund limits, but also because of fears that valuations had just got silly. Our insider signals tool also delivers a sell signal on the stock.
Nikola shares tumble (again)
Volume leaders today include Apple as normal, as well as Peloton after a blow-out earnings report – EPS of $0.27 almost treble the street consensus of $0.10 indicating the stay-at-home Covid trend is playing out well for the brand. A new cheaper version of its bike should help, too. Apple shares were flat, with Peloton up just +1%, well below its highs.
Hidenburg Research slams Nikola, shares tumble
Nikola shares fell about 15% on high volumes after the Hindenburg Research article. Whilst shares had fallen yesterday following publication, it seems investors have taken fright at the lack of any detailed refutation by Nikola.
A statement today from the company only said the allegations are not accurate and described the report as a ‘hit job’. If it is a hit job, it’s been a very well timed one with the stock having jumped only a couple of days prior on the tie-up with GM. But the lack of detail from the company so far has left investors unimpressed.
Without being able to comment on the details of the report, short attacks can and do happen, and more often than often there is rarely smoke without fire.
Equities move higher into the weekend
Elsewhere, the S&P 500 ticked higher after testing yesterday’s cash close at 3,339, with the 50-day line offering further support untested at 3,321.90. Yesterday’s tap on the 21-day SMA at 3,425 looks a long way off. Nasdaq also higher as risk is catching some bid into the weekend.
European equity markets are closing the day out with some decent weekly gains in the bag. Overall we have seen a real divergence between the US and Europe this week with equity markets this side of the pond doing better. Partly that is down to the rotation out of tech, but also we need to be aware of election risk that will play an increasing role in driving sentiment over the next month and a half.
Crude oil found some bid as the risk sentiment improved as the US session progressed.
Listening to the usual talking heads it seems there is more appetite for value after the three-day tech rout saw the penny drop for many that valuations had gotten out of hand. Let’s see how that goes with Ocado and Next on stage next week.
Brexit headline risk keeps pressure on GBPUSD
In FX, DXY ran out of gas at 93.38 as it tries to make another stab at the top of the descending wedge. GBPUSD tried three times to break below 1.2770 today but the level has just about held for now – sterling remains exposed to Brexit headline risks and bulls may be thin on the ground.
Post fix it looks pretty meek and liable to further downside into the weekend with UK-EU trade talks next week in focus. The current consolidation range looks pretty bearish and flaggy but we should always caution that sellers can get exhausted into the weekend just much as buyers can and there may be some profits being taken.
Ocado and Next teasers: Why do investors pay so much for growth?
Why do investors continue to pay such a premium for growth? Let’s take two FTSE 100 retailers – Ocado and Next, both of which report their latest trading numbers next week. Ocado delivers Q3 numbers on September 15th, with Next following with its half-year results on September 17th. The two companies offer rather different entry points into the UK retail space. Ocado carries tech-level valuations, and has been touted as the Microsoft of retail, whilst Next is relatively unloved despite its very respectable omnichannel mix and successful switch to online that has not been mirrored by all its peers. The respective CEOs – Lord Wolfson at Next and Ocado’s Tim Steiner are also rather different characters.
Ocado – Where is the Cash?
Ocado (LON: OCDO) shareholders will be keen to hear how management think the Marks & Spencer tie-up has gone so far. Investors will also want the answer to the perennial question – where is the cash? It likes to raise fresh funds to pay for its global expansion – raising another £1bn in debt and equity in June this year – but is less keen on actually generating it.
Ocado’s share price has rocketed this year thanks to the boom in online retail. Its +77% rally in 2020 puts it behind only Fresnillo in terms of YTD gains on the blue-chip index. However, it’s yet to really deliver any returns to investors by way of free cash.
Earnings from international partners remain slow to emerge and in July management cautioned that EBITDA from International Solutions would decline due to ‘continued investment in improving the platform and building the business, and from increased support costs with launch of initial CFC sites’.
Booming retail sales in the UK (+27% H1) are priced in, as are sustainable fees from international partners. The latter carries considerable execution risk.
Next – Retail bellwether
Meanwhile, retail bellwether Next (LON: NXT) (-16% YTD) is a cash cow that even with a collapse in the high street consistently manages to deliver free cash flow. The pandemic has proved more challenging – suspending buybacks and dividends, and selling off assets have been required to shore up the balance sheet this year. But it remains a resilient company able to generate pre-tax profit. Its half year results follow on Thursday.
In July the company reported that while full price sales in the second quarter were down -28% against last year, this was far better than expected and an improvement on the best-case scenario given in the April trading statement. Management guided full year profit before tax at £195m based on its central scenario.
If we know anything about Simon Wolfson, it’s that he likes to under promise and over deliver – albeit there are risks, as Dunelm stressed today, that a second lockdown could damage demand going into Christmas. In the more optimistic scenario laid out in July, pre-tax profits would be £330m – we are yet to see if high street footfall has made a genuine difference.
After peaking in February at £1.15bn, under the central scenario Next expects net debt to close the year at £648m, which would be a reduction of £464m in the year.
Despite generating cash every year, Next’s share price has lagged Ocado’s significantly over the last 5 years.
And taking this simple peer analysis, on both return on equity and price to cash flow metrics, Ocado looks very richly valued.
(charts and data from Markets.com, Reuters Eikon)