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BUY: Unite Group (UTG)
The student accommodation developer posted an increase in valuation in the face of the wider real estate downturn, writes Mitchell Labiak.
Unite Group outperformed the sluggish real estate market in its results for the previous calendar year by posting a 4 per cent increase in the value of its portfolio. This had the effect of nudging up its pre-tax profit at a time when many of its peers in the listed real estate investment trust (Reit) space are swinging to big losses.
There are good marks for Unite operationally as well. Rental income increased 15.6 per cent which the Reit put down to demand for continued student accommodation “underpinned by demographic growth, high application rates, and increasing international student numbers”. Put another way, there is a severe dearth of homes for students, which allows Unite to make money even when the wider property market is in a downturn.
The price is also attractive now. Historically, Unite’s position as the biggest player in the high-growth student housing market has put it at a premium to net asset value (NAV). This remains true, but the current premium is much lower than it has been in recent years, indicating an opportunity for investors if Unite continues to thrive as the economy improves.
Indeed, maintaining its performance will be tough for Unite. To meet the evident demand for student accommodation and continue to grow at a rate to justify its premium to NAV, it will need to develop more housing. In a high interest rate environment, this will be more expensive — but it is still in a much better position than those Reits developing assets into sub-markets with less obvious and immediate demand.
SELL: Travis Perkins (TPK)
The builders’ merchant’s share price has rallied but there’s no sign yet of a turnround, writes Michael Fahy.
If, as is generally accepted, markets price in a recovery well ahead of one taking place, that would go some way towards explaining why shares in Travis Perkins have rallied by about 40 per cent since last September. Either that, or investors felt the 60 per cent sell-off in its share price in the preceding 12 months had been overdone.
On the basis of its current performance, though, the bounceback feels a little premature. Although revenue increased by 9 per cent last year to just shy of £5bn, this was largely the result of it raising prices to tackle cost inflation. Prices rose by 15 per cent group-wide, but volumes weakened by 6 per cent.
The drop was most keenly felt in the home improvement market and worsened as the year progressed due to “high levels of material inflation and increasing macroeconomic uncertainty”. The company warned that this is likely to continue throughout 2023. And although activity among housebuilders held up, this was because they focused on building out current schemes, with a slowdown in new starts also set to bite this year. By contrast, both the public sector and the commercial and industrial markets (which make up about 46 per cent of merchanting revenue between them) continue to perform well.
However, the Toolstation business, which targets smaller builders and retail customers and provides around 15 per cent of group revenue, racked up losses. It continued to roll out new stores across the UK and Europe despite weaker sales, and lost £8.9mn on an adjusted basis, compared with a £22mn adjusted operating profit in 2021.
Group-wide operating profit fell by 18 per cent to £285mn. Chief executive Nick Roberts put on a brave face, describing the performance as “resilient”. The fact that he used the same word when discussing prospects for 2023 shows that they’re hardly glowing. The board expects performance to be in line with market expectations, which aren’t too pretty — the FactSet consensus forecast is for a second successive double-digit decline in earnings per share this year. Travis Perkins’ shares currently trade at over 12 times forecast earnings, in line with their five-year average but above the current consensus price target among brokers covering the company.
With the Construction Products Association forecasting a 4.7 per cent decline in the sector this year, this feels a little too pricey for us.
HOLD: Reckitt Benckiser (RKT)
Nutrition sales boomed on the back of a rival’s problems in the US, but it is not expected to last, writes Christopher Akers.
Reckitt Benckiser’s volumes felt the pain from lower post-pandemic disinfectant demand and the impact of Chinese lockdowns in 2022. But the consumer goods company, whose brands include Dettol, Lysol and Lemsip, offset this with big price increases and took full advantage of the misery of an infant nutrition competitor in the US to boost sales.
Volumes fell by 2 per cent in the year, which worsened to a 6 per cent decline in the fourth quarter. Lysol disinfectant — unsurprisingly — particularly struggled against elevated pandemic comparatives.
But price rises, which included a 12 per cent uplift in the last three months of the year, drove Reckitt’s revenues higher. While like-for-like net revenues fell by 3 per cent at the hygiene division, they boomed at the health and nutrition segments by 15 per cent and 23 per cent, respectively. Going forwards, however, to what extent shoppers will happily pay inflated prices remains to be seen.
The eye-catching nutrition revenue growth was helped by a strong, if out of the ordinary, infant formula performance in the US. Management’s comment in the results about a “competitor supply shortage” referred to the problems at Abbott Laboratories, which had to recall formula and other products from a plant in Michigan after customer complaints about bacterial infections. Reckitt plugged the supply gap and attributed 18 per cent of divisional growth to the issue.
Further down the income statement, the earnings figure stood out against the loss in 2021. But the difference doesn’t look quite so striking after considering that pre-tax profits turned negative in the previous year due to a £3.5bn loss on disposal from the sale of low-margin and underperforming operations such as the infant formula business in China.
Excluding that business from the calculation, the adjusted operating margin rose by 90 basis points to 23.8 per cent. Gross margin was down by 70 basis points due to eye-watering 17 per cent inflation in the cost of goods base.
Elsewhere, brand equity investment as a percentage of net revenue fell by 80 basis points, albeit management has guided that it will boost investment this year.
RBC Capital Markets analysts said that “increased R&D spend, the absence of negative one-offs and market share momentum add conviction that underlying performance is improving at Reckitt”. But they also noted that margin guidance for 2023 suggests a 2-3 per cent downgrade to consensus operating profit expectations.
This was a resilient performance, but the infant formula boom will reverse. And volumes could contract further given the reaction of consumers to price rises.
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