JP Morgan’s Favourite European Mid-Cap Equity Ideas

Posted on 17/05/2011

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Given that the bulk of my equity investments are in US-listed companies, I’ve become a little conscious that I might be neglecting good investment ideas in companies that operate a little closer to home.  So, in order to start the process of looking for new ideas in Europe, I’ve got my hands on a copy of JP Morgan’s European Small/Mid-Cap Valuation table and I include below a list of the top ten investment ideas sorted by forecast return (based on the difference between the price target and the current share price).

  1. Pace (LON:PIC) – 91% Expected Return.  Pace, a manufacturer of television set-top boxes recently issued a profit-warning citing higher component costs, supply-chain issues following the Japanese tsunami, insufficient demand at Pace Networks, and disappointing profitability at Pace Europe.  JP Morgan believe that management will be able to return back up towards 8% as they get to grip with the current issues.  Consequently, they see Pace trading at an FY12E EV/EBITDA multiple of just 1.9x.  Given the sheer range of issues facing the company, I’m far from convinced.  Mark Carter has already done some good work analysing the situation.
  2. Ageas (EBR:AGS) – 89% Expected Return.  This Belgian insurance company trades at a significant discount to their analyst’s sum-of-the-parts model.  They say: “The short conclusion is that we continue to believe that the “general account” (i.e. all the non insurance assets) is worth roughly €1 per share, of which 2/3 is explained by cash. Stripping this out from the share price means that the insurance operations are also therefore implicitly valued at about €1 per share, equivalent to a P/E of 3.4x or P/EV of just 10%.”
  3. Barratt Developments (LON:BDEV) – 77% Expected Return.  JP Morgan believe this UK housebuilding firm will see its near-50% discount to NAV per share close over time.  I recently reviewed competitor Persimmon and was sceptical that the UK housing market would see a turnaround in the near-term.
  4. Trinity Mirror (LON:TNI) – 70% Expected Return. “Revenues are declining but every asset has its price” says the JP Morgan headline.  Despite the declining revenues and generally negative outlook for the newspaper publishing industry, JP Morgan state: “Cash for free – in our cash flow analysis – which assumes a 7% per annum top-line decline – we conclude that the cash flows until 2020 (after debt repayment and pension contribution) are already sufficient to recoup the current market cap and turn the company debt-free in 2017.  In other words, an investor would get any cash generated post that year for free!” Therefore, the analyst thinks the investment may be of interest to deep-value investors.
  5. Mediaset (BIT:MS) -60% Expected Return. Mediaset is the Italian media conglomerate controlled by Italian Prime Minister Silvio Berlusconi with a 38.6% shareholding.  JP Morgan believe the shares trade at a substantial discount to their sum-of-the-parts valuation, though don’t provide a particular in-depth analysis of how they reached their conclusion.  In addition, they have recently moved down their price target from €7.50 to €6.80, so I’m not sure how much confidence I could gain from their analysis.  The company does have a chunky dividend yield of 8.3%.
  6. Phoenix Group (LON:PHNX) – 59% Expected Return.  This is the UK closed life insurance company which was previously known as Pearl Group.  The company has recently undergone a major financial restructuring and still needs to de-gear its balance sheet as it faces a significant debt maturity in 2014.  JP Morgan believe that the company will easily be able to generate enough cash to handle intermediate debt-repayments and de-lever sufficiently that a 2014 refinancing will not be a problem.
  7. ITV (LON:ITV) – 50% Expected Return.  Again, JP Morgan base their analysis on a sum-of-the-parts/DCF model and have recently been downgrading their price target.  The recommendation is by the same analyst that produced the Mediaset recommendation and I’m unconvinced in the target price given it uses a WACC of 8.7% despite the company having a negligible amount of net debt.
  8. TF1 (EPA:TFI) – 46% Expected Return.  TF1 is a French television broadcasting company with a range of channels and a number of other media operations.  As with Mediaset and ITV, they value TF1 using a sum-of-the-parts methodology and again I’m sceptical given the discount rate chosen (9% cost of equity) and some of the multiples used (3x sales for one business unit).
  9. Tecnicas Reunidas (MCE:TRE) – 46% Expected Return.  This company operates as an oilfield services provider and JP Morgan believes the business will benefit from further new contract wins given a record-sized bidding pipeline.  They find the valuation discount versus rivals difficult to rationalise given a similarly strong pipeline and believe that the contract backlog is likely to increase further.
  10. Millennium & Copthorne (LON:MLC) – 45% Expected Return.  JP Morgan note a strong recovery in hotel M&A activity in London and that this has sent asset prices to record levels.  Consequently, they believe: “the group’s EV, less the £350m stake in listed REIT CDLHT, can be justified by valuing the London estate at £650k per room with all other owned assets for free.”  They note the business is trading at an EV/EBITDA discount of 8% vs European peers and 30% vs US peers.  In addition, they believe that NAV is under-reported given in doesn’t take account of highly-likely development gains in Kuala Lumpur, Singapore and China.

Of all the ideas, the one that most attracts me is Ageas, followed in no particular order by Trinity Mirror, Millennium & Copthorne and Phoenix Group.  The presence of Barratt Developments on the list also suggests it might be worth taking a look at another UK housebuilder after recently dismissing Persimmon.  I’m sceptical of all the media recommendations that are based on sum-of-the-parts analysis as I’m uncomfortable with the low discounts rates and high multiples used to calculate them (3x sales for ITV4 anyone?).  While Pace looks good value, I’m cautious (wimpish) about buying into a business which as just issued a major profit warnings, particularly one that blames a number of different issues.  These things tend to be recurring.  Pace also sells a relatively commoditised product and shouldn’t expect great returns on capital over the long-run.  Time-permitting, I’ll post more on some of these ideas in the near-future.

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