Morning Note: Market news and updates from InterContinental Hotels and Becton Dickinson.

Market News

US equity markets rose last night – S&P 500 (+0.9%), Nasdaq (+1.5%) – amid easing geopolitical tension as AP reported that Hamas is sending a delegation to Egypt for cease-fire talks, a new sign of progress in attempts to end the war. The oil price slipped to $83.80 a barrel.

Apple rose by 6% in the after-market after saying sales will return to growth this quarter. Revenue and profit beat as China demand surprised on the upside. The iPhone maker announced an additional $110bn buyback, the largest in US history, and increased its dividend.

This morning in Asia, markets were mixed: Nikkei 225 (holiday); Hang Seng (+1.4%); Shanghai Composite (holiday). The yen surged to a three-week high. The FTSE 100 is currently trading 0.3% higher at 8,198. Anglo American is trading another 3% higher after Reuters reported that Glencore is reviewing an approach for the miner. Glencore (-2%) has not yet approached Anglo, one of the sources said. The discussions are internal and preliminary at this stage and may not result in an approach, the source added.

US non-farm payrolls for April are due out later today, with 232K expected. The 10-year Treasury yields 4.58%, while gold trades at $2,302 an ounce. Sterling currently buys $1.2542 and €1.1692.

The ECB will probably cut rates three times this year instead of four, Yannis Stournaras told Liberal. Philip Lane said the central bank is taking a meeting-by-meeting approach and isn’t pre-committing to a particular rate path.

Source: Bloomberg

Company News

InterContinental Hotels Group has today released its Q1 trading update which highlights a slight slowdown compared to the previous quarter. The share buyback programme is ongoing, and the group has announced changes to its System Fund arrangements. The shares have been strong over the last year (+42% total return) and have been marked down by 1% in early trading this morning.

IHG owns a portfolio of 19 attractive brands across all price tiers (including Crowne Plaza, InterContinental, Holiday Inn, and Six Senses) and has a strong operating system, both of which drive customer loyalty and pricing power. The group operates a highly scalable, asset-light model, based on franchising and management contracts, with low capital intensity and high returns. The model also means the group doesn’t bear the operational costs of running a hotel. The company is focused on delivering industry-leading net rooms growth over the medium term. It currently has a 4% global market share and a 10% share of the new room pipeline. At the end of 2023, the global estate was 946,382 rooms across 6,368 hotels, with 66% in midscale segments and 34% in upscale and luxury. Gross revenue generated by the group’s hotels is more than $31bn.

Long-term growth is being driven by a rising global middle class with a desire to travel. In the business market, IHG’s weighting is towards essential travel and non-urban markets. Earlier in the year, the group set out a financial framework for the medium to long term, targetting:

·       high single digit percentage growth in fee revenue, though combination of RevPAR and system size growth, together with 100‑150bps fee margin expansion, annually on average.

·       100% conversion of adjusted earnings into adjusted free cash flow, supporting investment in the business to optimise growth, sustainably growing the ordinary dividend and returning surplus capital.

·       12-15% adjusted EPS compound annual growth rate, including the assumption of ongoing share buybacks.

During the first quarter, global revenue per available room (RevPAR) – the key measure of industry performance – grew by 2.6%. As expected, this was slower than the previous quarter, but also slightly below market expectations. The guest appeal of the group’s brands has continued to support pricing, with average daily rate up 2.3%. Occupancy rose by 0.2 percentage points to 62%.

There is still a wide regional variation across the business. In Americas (the group’s largest division), RevPAR slipped by 0.3% in Q1 as the timing of Easter led to lower demand in late March including for Business travel. However, this was followed by higher demand in April, such that trading over the last eight weeks in aggregate has seen US RevPAR ahead of last year.

The EMEAA region bounced by 8.9%, with particular strength in Japan and Australia. In Greater China, RevPAR rose by 2.5%, with Tier 1 cities seeing RevPAR up 7.3%, reflecting the continued return of international travel. The performance in Tier 2-4 cities was down -2.1%, given tougher comparatives. The region will continue to benefit from returning international inbound travel this year. 

IHG continued to open new hotels and sign rooms more into its pipeline as it benefits from a ‘survival of the fittest’ bias as many smaller competitors exit the market. During the first quarter, 6,275 rooms across 46 hotels were opened. Gross system size grew by 5.0% year-on-year, while after removals, net system size growth was 3.4% year-on-year. Conversions from other brands accounted for 35% of combined openings and signings, a big positive given the time to open is much shorter than with a new build.

IHG signed 17,666 rooms (129 hotels) in the quarter, up 7.1%, to give a global pipeline of 305,405 rooms (2,079 hotels), up 6.6% year-on-year, and 32% of the current system size.

Last month, the group signed a long-term agreement with NOVUM Hospitality that will double its presence in Germany to more than 200 hotels in almost 100 cities. Conversion of the hotels to IHG’s system (as Holiday Inn, Garner, or Candlewood brands) will happen in phases beginning this year, with the majority to take place over the next 24 months. This will increase IHG’s global system size by up to 1.9% over the coming years, although the impact on fee growth will be lower.

The group has also announced changes to its System Fund arrangements, improving owner economics and growing IHG’s high margin ancillary fee streams. Given the highly successful growth and development of the IHG One Rewards loyalty programme, IHG has established new terms that govern assessment fees that owners pay into the System Fund and the sharing arrangements for ancillary fee streams such as those related to the sale of loyalty points. On the call, the company stressed that the change won’t lead to a reduction is the level of marketing financed by the System Fund and that it will be cash flow accretive.

As usual at this stage of the year, the group doesn’t provide an update on profitability or its financial position. The asset-light model means IHG has low investment requirements and a negative working capital cycle. The group operates a conservatively leveraged business model and maintains strong liquidity. At the end of last year, net debt was $2,272m, with gearing of 2.1x EBITDA, well below its 2.5x-3.0x target range. In response, the group is returning surplus capital through share buybacks - $239m of the current $800m programme (5% of market cap.) has been acquired to date, with the programme expected to complete this year. This will still leave end-2024 gearing at the lower end of the target range.

Looking ahead, whilst there are geopolitical risks and economic uncertainty in some geographies, current conditions, including employment, consumer savings, and business activity levels, remain supportive of industry growth. Near-term growth is also expected to capture several tailwinds, including: the last stages of a full post-pandemic recovery in several countries; further recovery in occupancy levels for business travel and for groups, meetings, and events; the full restoration of international flight capacity; and further potential for room rate increases driven by the growth in demand, constrained net new supply in the short term, and any ongoing inflation.

Overall, the company remains confident in the strengths of its business model, scale, and in its strategic priorities to capture sustainable, profitable growth.

Source: Bloomberg

Yesterday lunchtime, Becton Dickinson released results for the three months to 31 March 2024, the second quarter of its financial year to 30 September 2024. The figures were better than expected, with strong margin and free cash flow performance. The group raised earnings guidance for FY2024 and is confident of meeting its goals despite the second-half bias to the results. In response, the shares were marked up by 3% 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 BD 2025 Strategy is targetting 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 – the diabetes care unit has been spun off and the surgical instrumentation platform sold. In addition, the group is exiting lower margin products and markets – the number of stock lines has been cut by 20%, achieving the 2025 target a year early, with further a further reduction expected. The result is a more simplified portfolio and increased efficiency able to drive improved operating leverage.

In the latest quarter, revenue was up 4.7% on a currency-neutral basis to $5,045m, in line with the market forecast, and including the impact of the disposal of the surgical instrumentation platform. Organic growth (i.e., excluding acquisitions) was 5.7%, an acceleration from the previous quarter, driven by strong volumes.

By region, growth in the US (+6.3% to $2,906m) outpaced the International business (+2.6% to $2,139bn). China remains a challenge (-2.9%), stemming from value-based pricing and a slowdown in exports of pharmaceutical products.

By division:

·       BD Medical (49% of sales) grew by 3.7% in organic terms, driven by Medication Delivery Solutions and Medication Management Solutions. The group announced it is further increasing domestic production of syringes to support US health care needs following the latest FDA safety communication regarding certain non-BD plastic syringes.

·       BD Life Sciences (26% of sales) was up 2.3%, driven by Integrated Diagnostic Solutions offset by a tough year-on-year comparative in Biosciences.

·       BD Interventional (25% of sales) rose by 13.6%, driven by good performance across the division as a result of increased uptake of new products.

Over the last couple of years, the group acted early to deal with rising input inflation and supply chain issues. In the latest quarter, margins came in ahead of management expectations – the gross margin only fell by 100bps at constant currency to 53.0%, while the adjusted operating margin rose by 190bps at constant currency to 24.3%. Adjusted EPS rose by 12.6% on a currency-neutral basis to $3.17, well above the market forecast of $2.99.

The group has generated $1.1bn of cash flow in the financial year to date, up $0.9bn, to leave financial gearing at 2.6x net debt to EBITDA, just above the target of 2.5x. 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 has launched more than 50 key new products in the past two years and is on track to launch 100 products through to 2025, generating incremental revenue of $1.7bn versus $0.8bn in 2020. In the latest quarter, the group spent $284m, down 10%.

BD also plans to deploy $1.5bn-$2.0bn per year on tuck-in acquisitions. A progressive dividend policy has been maintained for 52 consecutive years, with an indicated annual rate for FY2024 of $3.80, up 4.4%, and equal to a yield of 1.6%. The group also bought back $500m of its own shares.

Last summer, Becton received FDA clearance for its Alaris Infusion System, a product that was removed from the market in 2020 following a call for more information on a software upgrade. The group is gradually resuming full commercial operation with an enhanced and updated market-leading system that can safely deliver medications, fluids, and blood products to support patient care. The ramp-up of the product has been faster than planned, with an all-time record number of pumps manufactured and shipped.

The group has entered the back half of its FY24 financial year with continued momentum and has raised its full-year earnings guidance:

-          Base organic revenue is still expected to grow by between 5.5% and 6.25% to $20.1bn-$20.3bn.

-          The operating margin is still expected to grow by at least 50bps (vs. 23.5% in FY2023) with a flat gross margin (53.5%) and positive SG&A leverage. Operating margin in the current quarter (Q3) will be modestly higher than Q2.

-          Adjusted EPS of $12.95 to $13.15 is now expected (vs. $12.82-$13.06 previously), a 11c increase (1%) at the mid-point. This includes absorbing an estimated 75bps negative impact from the divestiture of the Surgical Instrumentation platform.

Given the second-half weighting of the guidance, the company still has much to do to satisfy the market, but this update provides further optimism. Once the call, management said the increased contribution from Alaris means the base business only needs to grow revenue by 5%, while increased confidence over margin progression comes from visibility over cost savings and raw materials inflation.

Source: Bloomberg