Morning Note: Market News and updates from Ferguson and BAT.

Market News

Bond yields on both sides of the pond fell heavily yesterday – the 10-year Treasury now yields 4.18%, while gilts yield 4.04% – as US employment data bolstered bets that the Federal Reserve may cut rates as soon as March to avert a recession. Gold moved off its recent low to trade at $2,030 an ounce.

US equity markets were little changed last night – S&P 500 (-0.1%); Nasdaq (+0.3%) – while this morning in Asia, markets were generally more buoyant: Nikkei 225 (+2.0%); Hang Seng (+0.9%); Shanghai Composite (-0.1%). The FTSE 100 is currently trading 0.2% higher at 7,508, while Sterling trades at $1.2603 and €1.1685.

The oil price remains subdued at $77.30 a barrel as US exports add to oversupply concerns. Russia’s monthly income from oil exports is greater now than before the invasion of Ukraine, highlighting the failure of measures to curb its war chest.

China’s weakening earning are dashing hopes for a stock market rebound. About 30% of MSCI China Index members reported third-quarter results that missed, compared with 18% in the previous quarter, said Morgan Stanley. The bank said the trend of downward earnings revisions will continue into the first quarter of 2024.

Source: Bloomberg

Company News

Yesterday lunchtime, Ferguson released results for the three months to 31 October 2023, the first quarter of its financial year to 31 July 2024. Following a solid start to its year, the group has maintained its full-year guidance. In response to this update, the shares were marked up 4% during yesterday’s session.

Ferguson (formerly Wolseley PLC) is a leading specialist distributor in North America, providing expertise, solutions and products from infrastructure, plumbing, and appliances to HVAC, fire, and fabrication. The group sells to customers across residential, commercial, and industrial sectors, with revenue derived from a mix of new construction and repair, maintenance, and improvement (RMI). The business is exposed to several positive structural trends, such as an ageing population, smaller households, and the ageing of housing stocks, which drive demand for new housing and remodelling. The market for the group’s products is exposed to the economic cycle, in particular levels of activity in new construction and property repair. In FY23, Ferguson generated sales of almost $30bn.

The company reports in US dollars and has its primary share listing in the US. It is now evaluating the best manner and timing for domiciling the group’s ultimate parent company in the US.

During the latest quarter, the group was faced with tough year-on-year comparables. Revenue fell by 2.8% to $7.8bn, and by 4.9% on an organic basis. The year has started in line with management expectations, with continued market outperformance against a challenging backdrop. The decrease in sales was principally driven by a decline in residential, partially offset by growth in non-residential sales compared to the prior-year period. As expected, weakness in certain commodity categories drove modest overall price deflation of approximately 2% as the group lapped strong inflation comparables. Volumes fell 3%.

The largest business, the US (95% of revenue), fell by 5% in organic terms, with adjusted operating profit down 9.3% to $766m. Residential end markets, which comprise just over half of US revenue, remained subdued, while non-residential end markets, showed sequential stability. Commercial and industrial activity held up well and the group has continued to see good levels of mega-project related bid activity. In Canada, revenue fell by 3.3%, with profit falling from $33m to $23m.

The group’s gross margin was down 30 basis points to 30.2%, impacted by certain commodity categories. The adjusted operating margin fell by 90 basis points to 10.0%, despite disciplined cost control. As a result, operating profit fell by 10.5% to $773m, while EPS was down 10.2% to 265c.

The group continued to invest for organic growth – capital expenditure was $91m, with full-year guidance maintained at $400m-$450m. Free cash flow rose from $408m to $473m and the group ended the quarter with financial gearing of 1.0x net debt to EBITDA, at the bottom end of the target range of 1.0x-2.0x. The group has continued to consolidate its markets with one bolt-on acquisition during the quarter.

The group declared a quarterly dividend of 79c, an increase of 5%. A similar rise at the full-year stage would generate a yield of 1.8% at the current share price. Considering its prospects and strong financial position, the company is currently buying back its shares, having bought $108m in latest quarter, leaving around $400m remaining under the current programme.

Looking forward to FY2024, the group has reiterated its guidance for the year to 31 July 2024: net sales to be broadly flat and an adjusted operating margin of between 9.2% and 9.8%.

Source: Bloomberg

British American Tobacco has this morning released a trading update and strategy update. Its guidance for revenue has been trimmed and a big impairment charge has been taken in its US combustible business. In response, the shares have been marked down by 8% in early trading.

BAT is a global tobacco company with more than 200 brands. The group has Strategic Portfolio of priority brands made up of combustible tobacco products (including Dunhill, Kent, Lucky Strike, Pall Mall, Rothmans, Newport, and Camel) and New Categories (including vapour, tobacco heated products (THP), and modern oral, with brands including Vype, glo and Vuse). The group also owns a portfolio of other international and local cigarette brands.

This morning the group has confirmed its full-year 2023 EPS guidance of mid-single figure constant currency growth, including a 2% transactional currency headwind. However, group organic revenue is now expected to come in at the low end of the 3%-5% guidance range at constant rates. The group’s global volume share in combustibles is flat year to date, with value share down 40 basis points.

In combustibles, the US macro-economic environment remains challenging and is impacting performance, with recent signs of premium segment pressure after a more stable first-half. In response to current market trends, the group has taken a £25bn impairment charge mainly relating to some of its acquired US combustibles brands. In contrast, growth is strong in the AME and APMEA regions, reflecting the resilience of the group’s global, multi-category strategy.

Strong volume and revenue growth has continued in New Categories, led by Vuse and Velo, although the performance of glo has been disappointing. Overall, the group expects New Category contribution to be broadly breakeven in 2023, two years ahead of its original target. The group has also committed to ‘Building a Smokeless World’, with 50% of revenue derived from non-combustibles by 2035.

Looking forward to 2024, the group will increase its investment to accelerate its transformation and secure long-term sustainable growth. This cost of investment, alongside continued macro-economic pressures in the US, means the group now expects growth in revenue and adjusted profit from operations of low-single digit on an organic basis at constant rates. Further out, the group expects a progressive improvement to 3%-5% revenue growth, and mid-single digit adjusted profit from operations growth on an organic basis at constant rates by 2026.

The business remains highly cash generative, and the company expects to deliver close to 100% operating cashflow conversion in 2023. Progress is being made towards reaching the middle of the guided 2x-3x net debt/EBITDA leverage range, with 2.7x expected by the year end.

The group will continue to reward shareholders through strong cash returns, including a progressive dividend, and, once the middle of its leverage range is reached, the group will evaluate all opportunities to return excess cash to shareholders.

Source: Bloomberg