Market news and updates from Vonovia, Becton, and WPP.
Market News
The key US jobs report today may create more turbulence for Treasuries. Nonfarm payrolls are seen rising 200,000 in July, slightly less than the 209,000 increase in June. The whisper number suggests an increase of 220,000. Growth in average earnings is expected to cool to 4.2% year on year with the unemployment rate steady at 3.6%. A strong report will bolster bets that the Fed will tighten toward a peak of 6%, meaning potentially two more rate hikes. Treasuries steadied, recovering some overnight losses, but the slide in longer-dated notes put them on pace for their worst week of 2023. The dollar was little changed, while gold is $1,933 an ounce.
US equity markets ticked lower last night – S&P 500 (-0.3%); Nasdaq (-0.1%). Amazon rallied more than 8% post-market after its outlook topped estimates on strong e-commerce sales. Second-quarter earnings beat as revenue outpaced costs. Apple slipped 2% as iPhone sales disappointed and the company said revenue sluggishness will persist.
This morning in Asia, markets were steady – Nikkei 225 (+0.1%); Hang Seng (+0.6%); Shanghai Composite (+0.2%) – on fresh pledges of government support in China. The FTSE 100 is currently trading 0.2% higher at 7,535.
Andrew Bailey said it is too soon for the UK to declare victory in the battle against inflation and that the “last mile” will require a prolonged period of restrictive interest rates. The Bank of England governor spoke after hiking rates by 25 basis points. Sterling currently trades at $1.2710 and €1.1603.
OPEC+ will review the oil markets today, in the wake of Saudi Arabia’s decision to prolong its 1m b/d output cut by another month to September. The kingdom added that more cuts are possible, and Russia said it will extend a reduction in its crude exports into next month. Brent Crude is $85.40 a barrel.
Source: Bloomberg
Property News
Vonovia has today released its first-half results which highlight a 6.8% decline in its NAV. Ahead of this afternoon’s analysts’ call, the shares are down 2% in early trading, leaving them on a c. 60% discount.
Vonovia is Europe’s largest residential real estate company. The group owns around 548k units worth around €88bn across Germany (c. 89%), Sweden, and Austria. The group also manages a further 70k units owned by others. Despite its size, in Germany Vonovia still only owns 2% of a highly fragmented market.
The focus is on multi-family housing for low- and medium- income tenants in metropolitan areas. The aim is to benefit from residential megatrends such as urbanisation, energy efficiency, and demographic change. The population of Germany increased in 2022 driven by an influx of Ukrainian refugees which drove further demand for housing. Increased inflation, particularly in energy prices as well as shortages of materials used in construction, put pressure on construction costs and increased replacement costs to higher levels. Furthermore, the current market environment is discouraging new developments, exacerbating the supply/demand imbalance.
During the first half, funds from operations (FFO1) – effectively the group’s operating result – fell by 9.5% to €964.8m. Total segment revenue fell by 5.7% to €2,926m mainly due to lower volume-related revenue from the development business (-10.3%) and from recurring sales (-52.1%). The core residential property management business developed positively (+2.3%). The vacancy rate remains very low (2.2%) and highlights the ongoing mismatch between supply and demand.
The increasing trend towards higher rents continued. The organic increase in rent was 3.5%, of which new construction accounted for 0.8%. Like-for-like rental growth of 2.7% was driven by market-related factors (+1.5%) and investment in existing buildings (+1.2%). The monthly rent per square metre increased by 1.9% to €7.58. Going forward, under the regulatory system, rent growth is expected to follow inflation over time albeit with a lag. For the 2023 full year, growth of 3.6%-3.9% is expected.
Cost savings of €105m from the Deutsche Wohnen merger integration are being realised as planned. They are fully expected by 2024, with a further €35m from 2025. Over the long term, Vonovia has enjoyed increased benefits of increased scale, with its adjusted EBITDA margin up 20 percentage points and cost per unit down more than 60%.
Vonovia continued to sell properties that are of inferior quality or in non-core regions. The volume of recurring sales was 53% lower, although the fair value step-up remains above expectations, at 46%. The group has today suspended its guidance for recuring sales, and the current focus remains on liquidity generation over price optimisation. Outside of the recurring sales segment, 654 non-core units were sold (-96%) with a fair-value step-up of 9.2%.
In May, the company announced the sale of five real estate portfolios to CBRE Investment Management for €560m. The book value of the 1,350 new build residential units as of end 2022, plus the anticipated costs for completion, amount to around €600m. Vonovia expects a cash inflow after tax and transaction costs €535m, representing a cash conversion of 89%. During Q2, the group also sold a 34.5% minority stake in a 21,000-unit (Südewo) portfolio to Apollo, following which the company will continue to manage the properties. The deal raised €1bn, a discount of less than 5% to its fair value as of end 2022. Today, the group has highlighted a new JV portfolio has been identified in Northern Germany with a fair value volume similar to the Südewo portfolio.
Capital is being partly re-allocated toward the construction of new properties and the improvement of the existing portfolio to comply with environmental demands which can drive higher rents. In H1, the group spent €670m (-40%), with spend on maintenance down 17%, modernisation down 40%, and new construction spend down 67%.
During H1, the loan-to-value (LTV) increased from 45.1% to 47.2%, just above the 40%-45% target range. As a result of monetary tightening, the cost of issuing new debt has increased substantially. However, the group’s long-term and well-balanced debt maturity profile provides a hedge against increasing financing costs: weighted average maturity (6.9 years); average cost of debt (1.6%); fixed/hedged (96%); and no more than 12% of debt matures annually.
During the first half, the group rolled over €0.8bn of secured loans and took out €1.4bn of new loans (€0.6bn secured and €0.8bn unsecured). Since the period-end, Vonovia has completed a cash tender of €1bn of its bonds for a consideration of €892m, an 11% discount. This liability management exercise enabled the company to reduce its debt position, improve its debt coverage ratios, and strengthen its financial position within its credit ratings.
The pro-forma LTV adjusted for proceeds from CBRE transaction and bond buyback is 46.8%. The group has now fully covered its 2023 financial maturities and almost fully covered its 2024 financial maturities (€100m to go). Sales efforts across the different disposal clusters continue to also address 2025 financial maturities. The current theoretical headroom under the bond covenants is more than €9bn on the current fair value. As a result, we believe the company doesn’t need to raise new equity.
The group has reiterated its full-year guidance: funds from operations are expected to decline to €1.75bn-€1.95bn (-9% at the mid-point).
Since the end of 2022, the market value of the portfolio has fallen by 6.8% to €88.2bn. The net asset value (known as EPRA NTA) fell by 11.6% to €40.5bn. On a per share basis, the value fell by 13.6% to €49.67. The group says it is too early for a reliable H2 outlook, but the market appears to be showing the first signs of stabilisation.
The shares, which are listed in Germany, have fallen heavily over the last year and currently trade at a massive 60% discount to EPRA NTA. The main driver has been the close negative correlation with government bond yields which moved sharply higher – the 10-year bund is currently 2.59%, having been negative at the beginning of 2022. Similarly, higher interest rates and the resulting capital market fears of a knock-on effect on earnings and property values impacted the shares.
Although some visibility over the outlook for interest rates will be required for the shares to move substantially higher, in the meantime we are comforted by the substantial mismatch between Vonovia’s equity value (€2,415/sqm for the German portfolio), the valuation in the direct real estate market (as evidenced by recent market transactions, €3,500), and the cost of newly constructed properties (which are rising due to input price inflation, €5,300).
Source: Bloomberg
Company News
Yesterday lunchtime, Becton Dickinson released its June quarter results, which were slightly better than market expectations, and nudged up its guidance for full-year revenue growth. After an upbeat analysts’ call, the shares were marked down 1% during US trading hours.
Becton Dickinson (BD) is a leading global supplier of medical devices and instrument systems. The group’s products help achieve better healthcare outcomes, mitigate healthcare cost pressures, and improve healthcare safety. 90% of revenue comes from products where the group is the market leader, with 85% from recurring or non-capital related purchases. As a result, the company is well placed to benefit from increased demand for healthcare from an ageing population and in emerging markets. In the near term, revenue growth will be in part dependent on improving patient admissions and surgical volumes and a stable capital investment environment.
The group’s BD 2025 Strategy aims to deliver sustainable mid-single-digit revenue growth (i.e., 5.5%+), margin expansion of 540bps (to 25%), and double-digit earnings and free cash flow growth. The group is actively managing its portfolio – Embecta, the diabetes care unit, has been spun off into a separate public company and the Surgical Instrumentation platform in the Surgery business has been sold for $540m. In addition, the exit of lower margin products and markets has seen 2,500 stock lines removed, with the number of SKUs expected to be 20% lower by 2025. The result is a more simplified portfolio and increased efficiency able to drive improved operating leverage.
In the three months to 30 June 2023, revenue grew by 6.3% on a currency-neutral basis to $4.9bn, a touch ahead of the market expectation of $4.8bn. Base revenue, which strips out Covid-only testing, grew by 7.9%, with organic growth (i.e., excluding acquisitions) of 6.3%.
By region, growth in the US (+4.9% to $2.8bn) was lower than the International business (+8.2% to $2.1bn). By division, BD Medical (50% of sales) grew by 12.2%. BD Life Sciences (25% of sales) fell 5.0% but was up 0.2% excluding the reduced contribution from COVID-19 diagnostic testing revenue. BD Interventional (25% of sales) was up 8.1%.
Over the last year, the group has acted early to deal with rising input inflation and supply chain issues. The gross margin rose by 50bps at constant currency in the quarter to 52.6%, driven by leveraging strong revenue growth and continued execution of simplification and inflation mitigation initiatives which offset c. 200 bps of outsized inflation.
The operating margin increased by 150bps at constant currency to 23.0%, better than management expectations, and included a 100bps headwind from the accounting treatment of an employee benefit-related item. Adjusted EPS rose by 15.0% on a currency-neutral basis to $2.96, above the market forecast of $2.91.
Operating cash flow of $1.7bn has been generated year to date to leave financial gearing at 2.9x net debt to EBITDA, just above the group’s 2.5x target which is expected to be achieved by the year end. Cash flow is being directed to internal growth opportunities, bolt-on M&A, and shareholder returns. The group currently spends around 6% of revenue on R&D, with 60% directed towards what the company calls transformative solutions. The group is on track to launch 100 products through to 2025, generating incremental revenue of $1.7bn versus $0.8bn in 2020. The group also plans to deploy $1.5bn-$2.0bn per year on tuck-in acquisitions. A progressive dividend policy has been maintained for the 51 consecutive years, with the latest quarterly payment of 91c. The indicated annual dividend rate for FY2023 is $3.64 per share, up 4.6%, and equal to a yield of 1.3%.
Last month, Becton received FDA clearance for its Alaris Infusion System, a product that had to be removed from the market in 2020 following a call for more information on the product software upgrade. In response, the share price rose 8%. The group will gradually return to full commercial operation with an enhanced and updated market-leading system that can safely deliver medications, fluids and blood products to support patient care. Shipping of devices and revenue recognition will begin in 2024. The company expects that the initial investment to return the product to full commercial operation will be absorbed within its previously announced FY23 guidance range. Given the product has only recently gained approval, the company is being prudent with its revenue expectation.
Overall, the challenging macro-economic environment is expected to persist but not escalate. Input cost inflation is moderating but still elevated. Supply chain issues have stabilised, with less inventory held to the benefit of cash flow.
Full-year revenue guidance has been increased. Base business currency-neutral revenue growth is now expected to be 6.8%-7.1% (vs. 6.5%-7.0% previously). Organic growth is expected to be 5.65% (vs 5.5% previously). Growth in the current quarter is forecast to be 6%. The adjusted operating margin is still expected to rise by at least 100 bps to 23.6%, weighted to the second half, driven by a moderation of outsized inflation versus the first half, the simplification and inflation mitigation programs, and operating leverage on revenue growth. The group is currently tracking ahead of its FY2025 margin goals.
Guidance for adjusted diluted EPS has been maintained at $12.10-$12.32, with the increased base earnings (7c) offset by the Surgical Instrumentation platform divestiture (-2c) and currency headwinds (-5c). On a currency-neutral basis, the group is now guiding to 10.0%-11.5% EPS growth, 0.5% higher than previously. The implied Base business operational EPS growth is expected to be 14.4%-16.0%, also 0.5% higher than before, a terrific performance given the amount of cost inflation the group is having to absorb.
Becton also provided some initial guidance for FY2024: Base organic revenue growth of around 6% inclusive of a modest contribution from the re-introduction of the Alaris Infusion System, and EPS growth of around 10%.
Source: Bloomberg
WPP has this morning released its first-half results, which highlight subdued trading in the group’s key US market. Full-year revenue guidance has been trimmed, although the margin outlook has been reiterated, In response, the shares have been marked down by 7%.
WPP is a global communication services company which has undertaken a business improvement programme leaving it with stronger agency brands, a simpler structure, and a stronger balance sheet. The company believes the profound changes to consumer behaviour brought about by the pandemic have accelerated the need for companies to invest in digital technologies, e-commerce, and new customer experiences. Furthermore, the company has more than 120 clients with $20m+ of revenue, leaving a large opportunity to grow by providing more services to help clients optimise their marketing spend. The group’s strategic goals include:
- to return the core Communications business (i.e., media buying, creative, public relations, and branding) to sustainable growth.
- to expand further into high-growth areas of commerce, experience, and technology.
- to fund growth and improve profitability through gross annual cost savings of £600m by 2025, by further simplifying the operating model, generating efficiencies in procurement and real estate, and by improving the effectiveness of support functions and shared services. Two thirds of the savings are being used to fund investment in the capabilities and technology that will drive future growth.
In the first half of 2023, like-for-like (LFL) revenue less pass-through costs, the key measure of the group’s top-line performance, grew by 2.0% at constant currency, to £5.8bn, below the market forecast of +3%. The rate of growth decelerated through the half: Q1 (+2.9%); Q2 (+1.3%).
Performance by business sector was: Global Integrated Agencies (+2.2%), with GroupM, the group’s media planning and buying business, up 6.1%; Public Relations (+2.1%); and Specialist Agencies (+0.2%).
By region, North America fell by 1.2% in the half-year and by 4.1% in Q2 primarily due to lower spending from technology clients and some delays in technology-related projects. Elsewhere, growth was 8.2% in the UK, 3.7% in Western Continental Europe, and 3.1% in the Rest of the World. China grew 4.8% in the second quarter, as that market continued to recover from Covid-related impacts, albeit at a slower pace than anticipated.
New business performance remains strong, with $2.0bn won in the first half, albeit only $0.5bn in Q2. Wins included Reckitt, Mondelēz, easyJet, Lloyds Banking Group, Pernod Ricard, and India’s second largest advertiser, Maruti Suzuki. The group’s focus on AI over the last five years is paying off, with many examples of work with clients, using the main AI platforms, in-market today. The pipeline of potential new business is larger than at the same point in 2022.
Most of WPP’s costs are variable in nature and substantial actions have been taken to manage profitability and cash flow. Good progress on its transformation programme is being made, with the group on track to reach its target of at least £450m this year versus a 2019 base and £600m by 2025. The efficiencies are being used to grow the business, with continued investment in people and in data and technology.
The group’s ‘headline’ operating margin grew by 10 basis points on a LFL basis to 11.5%, as efficiency benefits were offset by investment in IT and higher severance costs. Headline diluted EPS by 0.3% at constant currency to 33.1p.
There was a net cash outflow in the first half of £1.0bn, compared to £2.2bn last year, driven by lower reported operating profit and higher consideration for acquisitions offset by a continued focus on working capital management and lower share purchases. Average adjusted net debt in the first half was £3.6bn, versus £2.6bn last year. The group expects year-end net debt to be flat year-on-year and continues to target net debt to EBITDA of 1.5x-1.75x.
The group allocates capital on a mix of:
- capital expenditure, with £300m expected in 2023.
- targeted, scalable M&A to expand the group’s presence in fast growing regions and its global offer in experience, commerce, and technology.
- dividend growth, with a payout ratio around 40% of headline EPS. The yield is currently around 5%. Today, a first-half dividend of 15p has been declared, the same as last year.
- share buybacks, albeit not at present.
In the near term, management expects the pattern of activity in the first half to continue into the second half of the year. As a result, the company has lowered its full-year guidance for LFL revenue less pass-through costs growth to 1.5%-3.0%, versus 3%-5% previously. The guidance for a headline operating profit margin of around 15% has been reiterated.
The group’s medium-term guidance remains unchanged: revenue less pass-through costs growth of 3%-4% and headline operating margin of 15.5%-16.0%.
Source: Bloomberg