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Investors Chronicle: Renew, Marks and Spencer, Ryanair

Buy: Renew (RNWH)

With further work likely to arise from the government’s promised infrastructure revolution, the outlook beyond this crisis remains promising, writes Nilushi Karunaratne.

Renew has not escaped the economic fallout of the Covid-19 pandemic, but its focus on essential infrastructure maintenance activities means 80 per cent of its work has continued. Rail, highways, water and telecommunications have all been designated as “critical” sectors. That is good news considering that more than 90 per cent of sales and adjusted operating profit are derived from engineering services.

Revenue from the largest division rose by 4 per cent to £293m, benefiting from emergency work in response to rail landslips and storms Ciara and Dennis. Adjusted operating profit increased by 7 per cent to £20.5m, with January’s acquisition of road engineering specialist Carnell bolstering the margin by 0.2 percentage points to 7 per cent. The purchase marks Renew’s entry into the highways market, which it has been eyeing for some time. Carnell is a “tier one” contractor with Highways England and will enable the group to tap opportunities in the new road investment programme running to 2025.

The acquisition has pushed net debt from £10.2m at the September year-end to £16.1m (excluding lease liabilities). But there was a £15.9m working capital inflow thanks to a £2.6m VAT deferral and faster payments from customers towards the end of the period. To preserve cash in light of Covid-19, the half-year dividend has been suspended.

House broker Numis anticipates pre-tax profit of £35.1m and earnings per share of 36.6p for the full year, rising to £39.6m and 40.6p the following year.

Renew’s preferred non-discretionary infrastructure markets are underpinned by long-term regulated budgets. This should prove defensive in the face of a wider construction slowdown.

Sell: Marks and Spencer (MKS)

Even without the impact of the lockdown, the group is still struggling to adapt to a fast-evolving retail environment, writes Alex Janiaud

Marks and Spencer’s clothing business set the retailer back once more at the March year-end, with difficulties in transitioning its menswear range through the second half coming on top of availability problems in womenswear during the first. Clothing and home operating profits slumped 37 per cent to £224m, with the division’s operating profit margin squeezed to 7 per cent from 10.1 per cent last year. M&S’s food arm had a stronger year, posting operating profit growth of 11.2 per cent to £237m.

The clothing and home division has sustained the heaviest impact from coronavirus within the group, and M&S is now modelling for a 70 per cent fall in revenues here in the four months to July, with a gradual return to normal levels by February 2021. This will hit annual turnover by around £1.5bn. 

M&S has written down £157m of inventories in response to the pandemic, £145m of which sat within its clothing and home arm. The retailer will put aside around £200m worth of its unsold seasonal stock until spring 2021 and carry forward £400m of year-round basic product, which will increase its stock carrying levels. Of the retailer’s £336m in adjustments to statutory profits, £213m related to Covid-19, while £49.2m was linked to the impairment of stores and goodwill.

FactSet consensus estimates forecasts full-year 2021 earnings per share of 4.87p, rising to 11.78p in 2022.

Hold: Ryanair (RYA)

The markets reacted positively to the group’s decisive measures, but much depends on the duration and severity of Europe-wide travel restrictions, writes Alex Janiaud.

Ryanair expects to record a €200m (£178m) loss in its first quarter as a result of the recent collapse in aviation traffic. Most of the airline’s fleet has been glued to the tarmac since mid-March and regardless of whether some flights are restored in July, the knock-on effects of the pandemic have been calamitous. The low-cost carrier anticipates carrying about 80m passengers over its 2021 financial year, well down on the 154m travellers it had targeted for the period.

Groundings in the period under review cut full-year traffic by 5m passengers, constraining pre-tax profits by more than €40m. However, trading patterns before the lockdown were encouraging. The group experienced a 10 per cent sales lift over its full-year, driven by a combination of traffic growth, fare increases and a 20 per cent jump in ancillary revenues, as more passengers opted for priority boarding and preferred seat services. But the airline’s overall pre-tax profits sustained a €353m blow linked to its 2021 fuel hedges, as the price of crude collapsed due to a sharp fall in global demand and Saudi/Russian inaction on production cuts.

Ryanair took swift action to keep on top of the high costs of being grounded with almost no income, and has cut its average weekly cash burn from €200m to €60m. It is negotiating with partners to reduce new aeroplane deliveries (including a 210 jet order for the disastrous Boeing 737 Max), with traffic expected to be substantially weaker over the coming year. It has also suspended share buybacks, having returned €581m to shareholders over its 2020 full-year.

Broker Citi forecasts full-year 2021 pre-tax losses and diluted losses per share of €829m and 66¢ respectively, before pre-tax profits and earnings per share of €615m and 49¢ in 2022.

Chris Dillow: The irrational minority

One common objection to the idea that share prices are driven by irrational investors is that, over time, they should be driven out of the market as the smarter money profits at their expense.

This is most obviously true in auctions. It doesn’t matter if most people in the room believe a painting is a worthless fake. If just two believe it is a masterpiece then a bidding war will see it sell for millions. And such wars are more common than you might think. In eBay auctions of Amazon gift cards — items with an obvious worth — two-fifths sell for more than their face value.

Prices are not set by “the market”. They are set by those who value an item more than the seller does — which can be a small minority.

This is true of one of the longest-standing of stock market anomalies — the long-run underperformance of newly floated stocks.

This also helps explain why we see booms and slumps in the numbers of new flotations. Such waves and troughs would not happen if flotations were determined only by companies’ thoughts about how to best structure their balance sheets: if so, they would occur more or less randomly. Instead, sellers put their company on the market when they believe there are enough investors around who are sufficiently over-optimistic to pay over the odds for it.

A similar thing happens in housing markets. Atif Mian and Amir Sufi estimate that the rise in US housing transactions between 2003 and 2006 was caused almost entirely by less than 1 per cent of the population — that small minority of Americans who were “flippers”, who bought and sold lots of houses in quick succession.

This explains something economists have long known — that price bubbles are often caused by easier credit. The point here isn’t that slacker lending standards allow most people to buy at high prices — if you are pessimistic about the market, the ability to get a big mortgage won’t cause you to buy. Instead, the mechanism is that easier credit gives fuel to the overconfident minority and so enables these to drive prices up further.

By the same token, even a moderate tightening of credit can have a disproportionate effect in depressing prices, because it drives overconfident buyers out of the market. Which is why property investors must guard against liquidity risk. If only a small minority of active and overconfident buyers drop out of the market, it will become difficult to sell quickly especially at a half-decent price.

Many of you might find all this banal. But in fact it undermines our everyday preconceptions. We should not speak of ‘the market’ as some abstract entity. Instead, there’s a set of sellers and set of buyers, all of whom have different beliefs. Often, prices are driven not by the average buyer but by a minority of them, who are not necessarily the most rational or informed. This is why it is so difficult to predict returns, especially for sentiment-driven assets such as the more speculative stocks: their prices depend on the beliefs of a small minority.

Markets are always selection devices, and they don’t necessarily select for the best. The idea that they do so is a just-so story, which is not always founded on the facts.

Chris Dillow is an economics commentator for Investors Chronicle


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