BUY: PureTech Health (PRTC)
With an extensive, but early-stage pipeline, investors need to have patience with PureTech Health, writes Julian Hofmann.
Assessing PureTech Health is not straightforward as the company’s results tend to sprawl as widely as its broad product pipeline. In common with the rest of the biotech sector, the share price has cratered over the past 12 months as investors pared back their appetite for risk. Indeed, there was a reported rise in short selling interest prior to these results.
On the face of it, there was nothing in the results to justify further shorting the shares. PureTech’s pipeline spans a broad range of products from cancer treatments that target hard-to-treat solid state tumours, irritable bowel syndrome, long Covid sufferers and others to treat pulmonary disorders. All, in one way or another, are based on monoclonal antibody technology. Management says that currently 13 of the company’s 27 drug candidates are in clinical trials, with two products cleared for marketing by the Food and Drug Administration — Plenity and EndeavorRx.
The increase in candidates in clinical trials will have a direct impact on costs and management acknowledges that the company’s capital requirements will increase substantially as its programmes mature. However, it has a cash runway expected to last through to 2025 without any need for dilutive fundraising. It has also been selling shares in subsidiary companies. For example, it sold two tranches of shares worth $218mn (£171mn) in its Karuna subsidiary in 2021 to generate capital.
PureTech will continue to burn through cash until more of its products reach the partnering stage for larger pharma companies. At first sight, the pipeline looks very broad, but the focus on monoclonal antibodies gives it a certain specialisation. The company is well funded for several more years and the value case for the shares has been strengthened by the general fall in sector valuations.
BUY: WHSmith (SMWH)
The removal of pandemic travel restrictions has helped drive the company back into the black, writes Christopher Akers.
WHSmith returned to profit as pandemic travel restrictions were eased in the period and its units in airports and railway stations benefited from holidaymakers unleashing pent-up demand for adventure.
Travel revenues were up by 125 per cent to £338mn and the business delivered a £15mn trading profit as consumers hit the road again. Post-period trading suggests that demand shows little sign of abating despite the cost of living crisis. For the eight weeks to April 23, travel revenues were at 114 per cent of pre-pandemic levels, a good sign as we head towards the crucial summer trading period.
The high street business increased profits despite facing new challenges. With its footprint — WHSmith’s has 537 high street stores, and has closed eight since September — the company is exposed to post-pandemic footfall trends as consumers continue to turn to online ordering. High street revenue was flat against the comparative, coming in at £270mn, but profit was still up by £2mn to £35mn for the half.
There was also an update on this month’s cyber security attack on Funky Pigeon, WHSmith’s online greeting cards subsidiary. The website is expected to return to normal service shortly (orders cannot currently be placed) and there is no “material impact” expected from the incident. Less encouraging is that Funky Pigeon’s revenue contribution fell by £8mn to £21mn and lower revenue and profits are expected for the year.
The shares are trading on a consensus 24 times forward earnings, which certainly looks appealing against the five-year average of 39 times. The direction of travel appears promising, with over 125 new stores in the pipeline.
HOLD: Associated British Foods (ABF)
While retail sales surged against the lockdown-hit comparative, ABF’s margin problems are going to last for longer than expected, writes Christopher Akers.
Associated British Foods’ shares have lost a third of their value over the past 12 months. Despite an increase in the Primark owner’s half-year dividend in these results, and soaring revenue and profits, the market was spooked by a warning that the hit to margins from cost inflation in the food business, due to the impact of Russia’s invasion of Ukraine, will be worse than expected this year. This sent the shares down 5 per cent on the day.
Chair Michael McLintock said: “We now expect a greater margin reduction in these businesses than previously expected for the full year” and “the full effect of margin recovery is now anticipated in our next financial year”.
While revenues grew in all food segments apart from grocery, margin and operating profit in this area of the business, which includes brands such as Twinings and Blue Dragon, are certainly something to be concerned about. Apart from sugar, the adjusted operating profit fell across all segments. Grocery, the company’s largest food sales contributor, suffered a 12 per cent drop while agriculture was down by more than a fifth.
Retail performance was the standout in these results. This was expected, given that stores were closed across the UK and Europe for much of the comparative period. Sales jumped by 64 per cent in constant currency terms to £3.54bn, albeit were down 4 per cent against pre-pandemic levels. A highlight was the performance in the US, which is a growth market for the company, where total sales were up by 37 per cent on a two-year basis. A strong pipeline of new stores is in place, looking ahead to the key trading period around next Christmas.
In other good news for the retail side of the business, the new Primark customer website has now launched. This allows customers to check stock availability in stores and showcases a wider range of products, but the fact that customers can still only purchase in-store is surely an obvious disadvantage when set against peers’ online offerings.
The shares are trading on a consensus 12 times forward earnings, significantly below the five-year average of 18 times. With an encouraging revenue performance and the recovery of retail, the share price collapse looks rather harsh. But with the company’s food inflation warning, we are sticking with our recommendation for now.
Chris Dillow: Index-linked gilts as protection
Index-linked gilts do not necessarily protect us from inflation. In the past six months they have lost 10 per cent as yields have risen; the 10-year yield is up 0.6 percentage points since October to minus 2.3 per cent. Coming at a time when CPI inflation has hit a 30-year high, this loss refutes the notion that linkers are a reliable protection from inflation. It is only if you hold them to maturity that this is the case. Otherwise, they can lose money in times of high inflation.
In truth, this shouldn’t surprise us. The yield on an inflation-linked bond should be equal to the path of expected short-term real interest rates over its lifetime, just as the yield on a conventional bond should be equal to the path of expected nominal short rates. If investors expect central banks to raise real interest rates in response to inflation — as they should if monetary policy is to tighten — inflation will raise real yields, causing a capital loss, which is what we’ve seen.
So far, so straightforward. But this poses the question: if linkers don’t always protect us from inflation, when do they prosper? It’s a trickier question than you might think.
Yes, sometimes they do well when equities do badly, for the same reason that conventional bonds do well; they are seen as a safe haven in times of high risk. Linkers did well during the tech crash of 2001-02 and the euro crisis of 2011, for example.
But they don’t always do well when equities sell off. In late 2008 and at the start of the pandemic in 2020 they lost money. This is because when investors fear deflation — falling consumer prices — they switch out of linkers and into conventional gilts.
Nor do linkers necessarily do well when oil prices rise. You might expect them to because higher oil prices raise inflation and threaten to squeeze the profits of non-oil companies. With one being bad for conventional bonds and the other bad for equities, linkers should therefore benefit. But in fact the combination we’ve seen in the past few months of rising oil prices and losses on linkers is not so unusual. Higher oil prices can be a sign of a stronger global economy and therefore bad for linkers as investors cut their demand for safer assets: we saw this, for example, in 2017-18 and in 2020-21.
A more robust relationship is the tendency for linkers to do well when sterling falls, as we saw in 2012-13 and after the vote to leave the EU in 2016. This isn’t just because a weaker pound can raise inflation. It’s also because it can be a sign of lower appetite for risk, which benefits safer assets such as linkers.
But again, not every fall in sterling benefits linkers. In fact, these would do badly if the Bank of England responds to a weaker pound by raising real interest rates. Since 1999 the correlation between six-month changes in sterling’s trade-weighted index and six-month returns on linkers has been minus 0.24. That means there’s a tendency for linkers to do well when sterling falls — but only that: a tendency, not a reliable relationship.
Index-linked gilts, then, are not strongly correlated with macroeconomic fluctuations, be it inflation, economic growth, exchange rates or commodity prices.
There is, however, one big fact about them. It is that until recently, they have delivered great long-term returns. From December 1999 to December 2021 they gave a total return of 7.1 per cent a year — 2.2 percentage points more than the All-Share index.
This, of course ,is just another way of saying that real yields have been trending down for decades: 10-year ones were over 4 per cent in the early 1990s but are less than minus 2 per cent now.
Herein, however, lies a threat to linkers. One reason for this downtrend has been a shortage of safe assets. Investors, especially in Asia and the Middle East, have wanted a safe home for their money but haven’t trusted their own banking or political systems or stock markets, and so have bought western bonds in the belief these were safe.
They were until recently. Western sanctions against Russia, however, have posed the question to wealthy people and organisations everywhere: if Russians’ assets in the west can be seized or frozen, why can’t those of other nationalities if the political winds change? Fearing this, Asian and Middle Eastern investors have less reason to trust the safety of western bonds. Which is one reason why they have sold off so much since Russia invaded Ukraine.
One factor behind falling real yields, then, has weakened — perhaps for good.
But only one. Other causes of low yields are still with us, not least of which is low economic growth around the world. The case for holding linkers is not so much that they protect us against short-term risks such as falling share prices or rising inflation, but that they protect us somewhat against the longer-term danger that western economies will continue to stagnate and so real interest rates will stay low.
Chris Dillow is an economics commentator for Investors’ Chronicle
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