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Investors’ Chronicle: Rolls-Royce, SigmaRoc, Capita

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BUY: Rolls-Royce (RR)

Rolls-Royce shares climbed as the sale of its Bergen Engines business was confirmed, writes Michael Fahy.

The aero engine supplier was one of a number of travel-linked companies whose shares rebounded as evidence suggested that the Omicron coronavirus variant is proving to be more transmissable though less deadly than the previously-dominant Delta variant.

Rolls-Royce said it will also retain €16m of cash. The money will be used to pay down debt.

The deal is the latest of a series of disposals by Rolls-Royce, which include the €1.7bn sale of its ITP Aero business in Spain in September to Bain Capital Private Equity, as it looks to rebuild its balance sheet.

The company said in August 2020 it expects to raise €2bn from asset sales as it bids to regain an investment-grade credit rating it lost a month earlier after Moody’s downgraded its debt.

Bergen Engines is based in Norway and makes medium-speed engines used in ships and power plants. The company employs 950 people and generated about €250m of revenue last year.

Rolls-Royce’s shares have see-sawed in recent months as good news about contract wins for the US military and funding for its small modular reactor consortium has been offset by renewed disruption to long-haul travel.

The company’s shares currently trade at 23 times FactSet forecast earnings, but a recovery in aviation should help to improve earnings and bolster ongoing efforts to repair its balance sheet. 

BUY: SigmaRoc (SRC)

Building materials group SigmaRoc agreed to buy Johnston Quarry Group and Guiting Quarry for £35.5m, writes Michael Fahy.

Johnston Quarry Group operates eight quarries and two processing sites across the South West, Oxfordshire and Lincolnshire. The quarries contain up to 86m tonnes of reserves, including building stone used for premium housing, aggregates and agricultural lime.

JQG generated revenue of £14.7m and pre-tax profit of £3.6m in the year to September 30, and had gross assets including land, reserves and machinery worth £22.1m, SigmaRoc said. It is buying the businesses from sellers Nicholas Johnston, Giantflow and Flowgiant and will fund the deal from its own resources, assuming £6m of JQG’s debt and £3.6m of plant hire leases.

Two additional quarries are being bought from the same sellers and have a “strategically attractive location relative to JQG”, SigmaRoc said. It expects these deals to complete between the second half of this year and the latter part of 2024, subject to conditions including possession of the necessary planning permissions.

SigmaRoc, which doubled pre-tax profit to £7.1m on a 56 per cent increase in revenue to £84.8m for the six months to June 30, operates from 76 sites across the UK and northern Europe, employing about 1,800 people. The company’s shares jumped 5 per cent to 88p, bringing their 12-month gain to 39 per cent, although they are 23 per cent off September’s high of 115p.

The shares currently trade at about 13 times earnings, in line with their five-year average. During this time, they have consistently outperformed the FTSE All-Share index and given the robust demand in the company’s end markets this doesn’t seem like much of a stretch.

SELL: Capita (CPI)

Capita continues to sell its non-core assets, and the completed sale of the Secure Solutions and Services unit has caught the regulator’s eye, writes Julian Hofmann.

As part of its bid to sell £700m of non-core assets, outsourcing company Capita had agreed the sale of its Capita SSS software business to rival NEC back in October in a deal worth £62m.

The aftermath of the transaction has been slightly complicated by the intervention of the Competition and Markets Authority (CMA) which issued a stop order to prevent the merger of Capita SSS with NEC. The CMA said it needed time to assess whether there is a competition issue, though the regulator did clarify that its order does not inhibit the completion of the transaction. 

The CMA wrote to both companies on December 21 to pause the combination of NEC and SSS operations. Capita announced the completion of the sale on January 3 and has received payment. 

While at this point there is no suggestion that the CMA could ultimately veto the deal, the stop order effectively prevents any exchange of information or personnel between Capita SSS and NEC. So, to all intents and purposes, the NEC and Capita SSS merger is stuck until the CMA makes its decision. 

Capita’s urgent need for cash lies behind the disposal of what it deems to be non-core assets. Prior to this, the company said it had raised £643m towards the £700m sales target for 2021. That total also included the announcement on Christmas Eve that Capita had sold AMT Sybex to Jonas Software for £40m, (£23m upfront, with the rest of the payments staggered).

The timing of the announcement so late in the year may be related to the fact that Capita will book a loss on AMT Sybex of approximately £42m, having acquired the Irish software developer in 2014 for £82m. The impression of a fire sale is further reinforced by the fact that Sybex held assets at the time of its disposal of £77m.

To be fair to Capita, the company is not far away from completing its target for disposals. The shares remain deeply submerged and it is hard to see any immediate catalyst for improvement.

Chris Dillow: A year of falling inflation

Inflation is rising. The Bank of England forecasts that the CPI inflation rate will hit 6 per cent in April, due largely to higher gas prices and to some price falls last January dropping out of the annual data.

The gilt market, however, is relaxed about this. Although five-year yields have risen significantly since last year’s lockdown, they are still only at the levels we saw in early 2019 when nobody was much worried about inflation. There’s a reason for this. It’s that inflation is likely to fall from the spring onwards.

Simple maths tells us this. From next spring onwards some price rises will drop out of the annual inflation data, such as petrol price hikes, the rise in VAT on hospitality and (eventually) higher gas prices. This will leave us with a higher price level, but a lower inflation rate.

And there are already signs of some price pressures easing. The price of Brent crude has dropped 8 per cent from its October highs, and those of copper, zinc and platinum have also fallen since then. One important lead indicator suggests these trends could continue. China’s money stock (on the M1 measure) has risen only 3 per cent in the past 12 months. Historically, this has led to weak growth in the country and hence to low demand for raw materials.

Another anti-inflationary force will be weak domestic demand. Higher gas prices, cuts to universal credit, higher national insurance contributions in April and an ongoing squeeze on public sector pay will all curb consumer spending. In that environment, retailers will struggle to raise prices much.

In fact, spending is already feeble: retail sales volumes in November were 2.8 per cent down on April’s level. People are not spending the cash piles they built during the lockdowns. Having grown by 12.1 per cent in the year to March 2021, households’ bank deposits have risen a further 3.8 per cent since then. Yes, fast growth in the money stock can lead to inflation. But only if that money is spent – and so far this is not the case.

Nor is there much evidence yet of a wage-price spiral. Official figures show that median monthly pay rose by 4.6 per cent in the year to November – which is a fall in real terms. And for every sector that has seen a real-terms pay rise (such as transport, IT and finance) others have seen significant cuts, such as in manufacturing, retailing and construction. Except in a few industries, workers don’t have the bargaining power to push for inflationary pay rises.

Fundamental domestic economic forces therefore point to inflation receding this year. This, however, is reason for only cautious optimism: a world in which gas supply is sensitive to Russian politics is not one which admits of great confidence.

But what if I’m wrong? Higher inflation than I expect is likely to be accompanied by weak demand – either because higher prices of gas or other key commodities squeeze real incomes, or because the Bank raises interests and thereby squeezes demand. In such a world, bond yields might not rise much, simply because investors will seek a safe haven against the risk of falling share prices caused by earnings downgrades or increased risk aversion. The possibility of higher inflation might be a reason to avoid gilts, but it’s not a reason to switch into equities.

Chris Dillow is an economics commentator for Investors’ Chronicle



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