Investors’ Chronicle: Unite Group, Reach, Nichols

BUY: Unite Group (UTG)

Student accommodation group Unite’s latest results indicate the market is looking strong, writes Mitchell Labiak.

School’s out for summer and investors in Unite will be pleased to see that UK university applications hit a record high this year. Just shy of 684,000 applied before the June 30 deadline — the highest number since UCAS started recording the data in 2009 — and this has translated into a surge in demand for student accommodation. The company’s rental income has risen to £128mn for the six months to June 30, which is not only more than the equivalent pre-pandemic period in 2019, but double it.

This does not mean that the pandemic was easy for any student or student landlord — with many of the former miffed about the idea of paying rent for accommodation they weren’t using when locked down at home — but what it does indicate is that rising demand for student housing is a trend which is bigger than Covid.

For Unite, a key part of the demand is international. Non-UK students made up 20 per cent of applications this year, but those non-UK students make up 35 per cent of Unite’s bed reservations. In other words, Unite has a higher-than-average dependence on the international market which leaves it exposed to the attitudes of various governments, particularly China, towards international study. Meanwhile, rising construction costs could hamper its development pipeline of 6,192 beds.

However, these are minor issues at a company which has emerged from the worst of the pandemic not just surviving, but thriving. With demand for UK university places looking likely to grow, this stock’s 17.6 per cent premium to net asset value looks like a fair price.

SELL: Reach (RCH)

The newspaper group’s turnround plan has been hampered by inflation, the war in Ukraine and squeezed advertising budgets, writes Jemma Slingo.

Reach is in the middle of an urgent transformation plan. The national and regional news publisher is moving away from print and into digital media, in a bid to keep up with consumer habits.

It has not been an easy first half. Print sales — which still account for about three-quarters of group revenue — fell by 3.9 per cent, with circulation and advertising both down. Boosting the price of newspapers failed to counteract an “unprecedented increase” in the cost of newsprint, which grew by 54 per cent year on year.

As such, the group’s adjusted operating profit fell by 32 per cent to £47.2mn. Statutory figures are more positive, but they are flattered by a large pile of one-off costs incurred last year.

Reach’s digital arm had a better six months, with revenue creeping up by 5.4 per cent to £72.5mn. The group is also attracting a wider audience and getting more page views.

There are still some major obstacles, however. The yield on “open market programmatic advertising” — which affects around half of total ad volumes — fell by 40 per cent in the second quarter. This was largely attributed to the war in Ukraine, which resulted in less “brand-safe” advertising space. Companies do not want to market their wares next to war stories.

Meanwhile, technological changes could threaten future revenue. In 2023, Google Chrome is set to phase out third-party cookies, making it harder for companies to track potential customers around the web. This development makes it more important than ever for publishers to collect data on their own readers. Reach is making progress here. About 11mn of its readers are now registered users, up from 5mn in 2020. However, this only represents a quarter of its total UK digital audience.

Reach’s strategy is a very sensible one. However, changes to cookies, rising costs and a possible advertising slump suggest the next 12 months will be an uphill struggle.

HOLD: Nichols (NICL)

The soft drinks manufacturer has taken steps to mitigate inflationary effects, writes Mark Robinson.

Shareholders in Nichols were the beneficiaries of a 27 per cent hike in the half-year dividend, mirroring revenue growth in its UK domestic market. You could say it’s a recovery play, at least judging by comments from eponymous non-executive chair John Nichols: “In the UK, the Vimto brand continues to outperform the broader squash market, and the group’s out-of-home route to market experienced good growth as the wider leisure sector continues to recover from the impact of the pandemic”.

The soft drinks producer, whose Vimto brand is a favourite during Ramadan, has been targeting efficiencies through the reordering of its UK operational supply chain. Measures have been taken to move its ‘dilutes’ segment to a new contract manufacturer in a bid to boost manufacturing capacity and take advantage of higher speed lines and more efficient bottling processes.

Everything comes at a cost, so Nichols has had to take on one-off hits linked to additional storage capacity, along with restructuring costs and legal fees. In all, the group incurred £1.2mn of exceptional costs during the year (H1 2021: £0.3m). And distribution expenses were on the fly, increasing by 9.6 per cent to £4.7mn due to a combination of higher trading volumes and significant inflationary pressure. Leaving aside one-off impacts, the adjusted operating profit increased by 24.2 per cent to £11.2mn.

Operations were hobbled through the first quarter of 2022 as disruption to shipments impacted its international business with US shipments constrained by container shortages and there were further difficulties linked to industrial action in Spain. The upshot was that international revenues contracted by 7.2 per cent to £17.6mn.

The gross margin fell by 160-basis points to 42.8 per cent, reflecting an unfavourable sales mix, specifically the higher proportion of lower-margin UK carbonate revenues as the ‘out-of-home’ market recovers post-pandemic. Revenues from this corner of the market increased by 131.9 per cent, albeit from a vastly reduced base.

The recovery in the out-of-home business has necessitated a reinvestment into working capital, so debtors and inventories are £8mn higher than at the year end. That’s unavoidable, but inventory levels have also been elevated due to increased ingredient and packaging costs. And it’s those costs which will have an outsize bearing on full-year profitability if macroeconomic challenges persist. Management has taken measures to mitigate cost pressures and efficiencies should follow from the supply chain changes, but with the shares trading at 23 times consensus earnings, the market appears to be up to speed with the changes.

Hermione Taylor: What the US yield curve tells us

The US yield curve is looking very interesting indeed. In normal times, yield curves slope upwards: investors are compensated with higher returns when they lock away money over the long term. This is because of the risks they incur — after all, 10 years is a long time in economics or anything else for that matter.

But recently, the US Treasury yield curve has ‘inverted’, with the gap between the 10-year and two-year yields turning negative, as the chart shows. In other words, the yields investors earn on short-term Treasuries exceeds the return on long-term ones. And as well as being unusual, this is troubling.

Yield curve inversions can be driven by changes at the short end and long end of the curve. And the past month has seen movement at both ends. At the short end, yields are sensitive to interest rate expectations. With US inflation at 9.1 per cent, more rate hikes are expected to follow. This makes locking in rates with a two-year note less desirable, reducing demand. And as prices of two-year notes fall, yields are pushed up.

Longer-term yields, on the other hand, tend to be driven by expectations about economic performance. If market participants expect a downturn, they bet that the central bank will later be forced to cut rates to stimulate the economy. This decreases expected borrowing costs in the future, and depresses the 10-year Treasury yield.

Yield curves are also influenced by market attitudes to risk. As concerns about recession escalate, investors look for a safe haven: Treasuries can provide this by offering refuge from choppy equities markets. Higher demand for 10-year notes increases prices, further depressing yields.

No surprise then, that inverted yield curves are seen as a signal of an impending recession. And a seemingly reliable one, too: according to research from the Federal Reserve Bank of San Francisco (FRBSF), yield curve inversions have preceded every US recession since 1955. On this side of the pond, there is evidence that the inverted yield curve’s power to anticipate a recession dates back as far as the 1800s.

So the record is pretty impressive. But how useful is it really as a recession predictor? Firstly, heed the maxim that ‘correlation doesn’t imply causation’. The evidence doesn’t imply that an inverted yield curve causes a recession. Rather, its slope fluctuates to reflect changing expectations about the economy — and it is these expectations that prove useful predictors of economic downturns.

If the yield curve is a useful recession indicator, it is also worth remembering that there are many others, too. Oren Klachkin, lead economist at Oxford Economics, said last week that “upbeat spending backed by a strong labour market and as consumers dip into their savings should keep the economy out of recession”. The yield curve may well signal a downturn, but other indicators suggest a more optimistic economic outlook.

What’s more, Fed economists Eric C Engstrom and Steven A Sharpe assert that the 2-10 spread offers a ‘particularly muddled view’ of impending recession. Instead, they argue that yields on Treasury debt with maturities of less than two years have better predictive power, by mirroring market participants’ expectations for economic performance and interest rate policy.

We also tend to be rather generous when ascribing predictive power to inverted yield curves too. The FRBSF found that between 1955 and 2018, an inverted yield curve did correctly signal all nine US recessions. But it also generated one false positive and couldn’t tell us much about when the recession would hit. In fact, it found that a yield curve inversion could precede a recession by anything from six to 24 months.

And a lot can happen in that time. After all, the curve briefly inverted in 2019, and the US economy did enter a recession in 2020. But as Engstrom and Sharpe wryly note, “pure statistical analysis will give credit, where credit is not due” to the inverted yield curve for predicting the Covid recession.

Hermione Taylor is an economics writer for Investors’ Chronicle