Morning Meeting Wrap

Pace of decline in Irish House Prices slows in Q2

According to the latest permanent tsb/ESRI index, house prices fell by 1.7% in Q2 10, bringing the average house price back to 2002 levels. Prices have now fallen 35% from their peak at the end of 2006. Encouragingly, the qoq decline also represents the smallest quarterly decline since Q2 2008. However, this slowing in the decline in house prices contrasts with the Q2 report from Daft.ie, released earlier this month, which showed that the pace of decline in asking prices picked up again in Q2 10 (-4.2% qoq) after slowing to -3.4% qoq in Q1 10 from -5.5% in Q4 09. A number of factors are required to before we see an improvement in the backdrop to the Irish housing market, including a more favourable labour market outlook, an improvement in credit conditions and an increase in confidence levels. While the slowing in the pace of price declines raises the prospect that an end to over three years in price falls may be in sight, there is clearly some way to go.

More to be done to improve to Ireland's international competitiveness

A new report from the National Competitiveness Council (NCC) shows that while Ireland's relative cost competitiveness, as measured by the EU's real harmonised competitiveness indicator (HCI), had improved between January 2008 and June 2010, it is still 14% above where it was in January 2000. This suggests that further progress is essential. Between January 2000 and January 2008, Ireland's HCI rose by 28% as the cost of labour, property, utilities and business services all outpaced those of our Euroarea partners. Since early 2008 some of these costs have been reigned in, particularly unit labour costs and industrial electricity costs, but in sectors that are not exposed to international competition, like broadband and legal fees, costs remain relatively high. Further improving Ireland's cost competitiveness is crucial to both attracting inward investment and to our export sector which is expected to drive growth over the coming quarters. In addition, as the recession has driven much of the improvement longer term structural changes are needed to protect against future loss of competitiveness.

Delivering on all fronts

Following yesterday's strong results from Travis Perkins (9% ahead, better merchanting margins and lower interest charge), we are upgrading FY10 earnings by 4%, driven higher lfl / margins in merchanting (5.7% / 9.7% versus 5.3% / 9.5%, previously) and a lower interest charge. This means adj. EPS goes from 75p to 78p. However, we are staying with our more cautious stance on FY11, with lfls in merchanting expected to moderate to 2.2% and decline in retail (-2.3%). This results in an adjusted EPS of 76p (up 1%). If these prove too conservative, we estimate every 1% shift in lfls for merchanting/retail impact EPS by 2-3%. The trading update from BSS for the four months to the end of July shows the business is performing strongly with lfl sales +7% and costs down 2.6%. Given this strong start to the year, we are now estimating the level of accretion in FY11 to be 11% and ROCE of 12%. So in our view this is a very attractive deal.

Based on our conservative assumption that the mid-cycle will be in 2014 and applying mid-cycle multiples (EV/sales 0.74x, EV/EBIDTA 7.4x and PE 12.3x) gives a value for the legacy business of almost 1100p. When the BSS deal is included, this goes to in excess of 1200p. Furthermore, management has conservatively estimated that the balance sheet carrying value of its properties is underestimated by at least £150m (this is supported by a track record of producing profits on disposals of assets), which implies a NAV nearer 840p. Our positive investment case on Travis Perkins is supported by a track record of delivering strong results, a highly accretive large deal, a NAV close to the current share price and the prospect of a progressive dividend policy (CAGR of 30% for next 5 years, assuming cover converges to 3.5x). As a result we reiterate our BUY recommendation with PT of 1225p

Partygaming/bwin merger details and potential

Partygaming, the UK based online gaming provider and bwin yesterday released details of a proposed merger. The resulting conference call outlined the structure of deal, which will take the form of a reverse takeover, with the new entity listing on the London stock exchange under the Partygaming banner. bwin shareholders will own 51.6% of the company, with Partygaming shareholders receiving a 48.4% stake. The Enlarged Group claims market leadership in all product verticals, i.e. - Online Sports betting, Casino, Poker as well as Games and Bingo. The new corporate will also be better positioned to take advantage of markets highlighted for deregulation (the "holy grail" of the USA in light of Barney Franks' current efforts to legalise online gambling), as well as previously regulated markets. Also, the merger will be of a complimentary nature with little overlap, with bwin for example heading up the sports betting side of the operation and committing to increase yields in this segment, while Partygaming will take the lead role in providing gaming and bingo expertise.

The annualised synergy figure of €55m outlined may prove a conservative estimate for the Enlarged Group. Synergies will be primarily driven by staff cuts and the cross-selling of products (€13m). During the call, it was projected that 80% of synergies will feed through to the bottom line in the first full year post the merger completion. Both companies currently boast net cash positions; however, guidance is to expand available credit facilities in order to take advantage of any future M&A opportunities. The new entity will therefore seek to become a market consolidator. The conversion rate under the terms of the agreement is that each bwin holder will receive 12.23 'New Partygaming' shares for every one bwin share held. We see bwin as a quality operator in the European online space with significant growth opportunities (both in Europe and USA), a view further enhanced by yesterday's merger announcement.

In our note on bwin "Conquering Europe" back in April, we set a price target of €59.50. This was based on a combination of valuation metrics. Using DCF we arrived at a price target of €58.84, which combined with an SOTP methodology (€49.73) gave us a core business value of €54.29. We then added a 30% weighting to potential business in Germany and Spain, giving a total price target of €59.50. Synergies of €55m are expected for the new entity, equivalent to c.25% of EBIT of the enlarged Partygaming/bwin, and clearly a significant amount of this will accrue to bwin shareholders. We will review our share price target in light of this. As things stand, our current share price target represents upside in any event of over 40% and we remain very positive on this stock. .

As expected Q2 trends have been better but read through is mixed

CRH

Results out today show that both St Gobain and Lafarge where ahead at the operating line, but broadly in line in terms of net income, while HeidelbergCement were in line at the operating level, but behind at the earnings level. Trends across the results are consistent, in that improvements continue in Q2, but market conditions in Europe remain difficult. Indeed, HeidelbergCement highlight that the construction market in the Netherlands is "weakening considerably". Furthermore, CRH's materials peer group appear to have done better in US aggregates, which highlights CRH's disappointing 8% decline in H1 volumes. See below for more detail.

Lafarge lowers cement outlook due to weaker Europe

Lafarge has reported Q2 operating profit of €836m, which is 9% ahead of Bloomberg consensus. However, Similar to St Gobain it is broadly in line at the net income level. As with all building materials companies, the sales trend improved in Q2 with lfl at -2% versus -8% in Q1, reflecting volume growth in North America and stabilisation in most mature markets (with the exception of Greece and Spain). It is of note in the US, aggregate volumes were up 8% in the first six months. On the outlook, Lafarge has lowered its cement outlook from "0% to 5%" to "-1% to 3%", with the key driver being downgrades in western Europe from "-3% to -8% to "-6% to 10%" and CEE from "-2% to 3%" to "-4% to 0%", which was partly offset by an upgrade to the US from "-2% to -3%" to "1% to 5%". Furthermore, its structural cost target of €200m is expected to be exceeded.

St Gobain ahead at operating level and increases FY FCF target

St Gobain has reported first half operating profit of €1,445m (+55% yoy), which is ahead of Bloomberg consensus of €1,355m (but at the net income it is broadly in line). Furthermore, management has increased FY FCF guidance from €1bn to €1.4bn and is targeting H2 operating to be "slightly above" H1, which compares to consensus of €2,752m. The improvement in profits was driven by incremental cost savings of €450m and lfl growth of 1.0%. The latter reflects an improvement in Q2 to 3.1% versus -2.4% in Q1. This growth was driven by its industrial related businesses (+14% in H1), while construction products was flat (-3% Q1 versus +3% Q2) and distribution was down 4% (-9% Q1 versus 0% Q2). From a regional perspective, the areas of strength were North America and Emerging countries / Asia (lfl +11% and 10%, respectively in H1), while lfl's where still down in France and other western European countries (both -2%), although both reporting regions were in positive territory in Q2 (+1% and +2%, respectively). On the outlook, it expects conditions to continue to vary across Europe (recovery in UK/Scandinavia and Germany, further declines in southern Europe and relative stabilisation in France), while momentum in America will be driven by industrial and household consumption related segments, but construction markets will remain fragile. It is also of note that it is looking to increase investment in H2, with a focus on Asia /emerging markets, energy efficiency and solar power.

HeidelbergCement behind with pockets of weakness in Europe

Heidelberg cement also released its H110 this morning. The company reports sales of €3,3bn for Q2 representing growth of circa 9.5% yoy (versus a decline of 8% in Q1) and is circa 5% ahead of Bloomberg consensus expectations. Operating profit increased by 10% during Q2 in line with expectations. However, EPS of 68c fell considerably short of 116c expectations. On a regional basis, while all regions have seen improvements, lfl's remain in negative territory in Western/Northern Europe (-1.1% versus -16% in Q1) and Eastern Europe/Central Asia (-12% in Q2 versus -32% in Q1). Overall, both European regions were affected by adverse weather and of note for CRH, HeidelbergCement management note the Benelux countries continue to experience weakness. On a positive note, North America reported lfl sales growth of 3%, improving on the -20% in Q1 (cement +9% and aggregates +2% in H1). With regard to outlook, management is optimistic over the prospects for Asia Pacific and Africa-Mediterranean, while the recovery in the US is expected to continue as expenditure on roads continues. Unsurprisingly residential is expected to lead the way in Europe, while commercial construction will continue to be weak and it also highlights the Netherlands as an area of weakness.

Another step along the road for highway investment

The House of Representatives approved yesterday investment of $45.2bn for highways in FY11. This would represent a 10% increase on the $41.1bn in FY10. The next step in the process is for the Senate to act on its version of the transportation appropriations bill and it is currently proposing $41.9bn. Any increase would be welcome as highway expenditures in the US face significant headwinds, due to difficult yoy comparatives from the stimulus and budgetary pressures at a state level. For CRH, we estimate that infrastructure represents 36% of its US operations.

Smurfit Kappa announce recycled containerboard increase

Smurfit Kappa

Yesterday, Smurfit Kappa announced a €60/tonne price increase for recycled containerboard grades to be implemented from September 1, which is in line with what both SCA and Europac recently reported. This price increase comes shortly after the company announced a similar increase on Unbleached Kraftliner recently and the company attributes this hike to a necessity for cost recovery and positive market dynamics. We believe the increase is well underpinned by a number of factors;

1. an extremely tight Kraftliner market (RISI's latest forecasts point to a capacity utilisation rate of over 95% for FY11), which underpins Testliner demand via a substitution effect;
2. buoyant Testliner exports; and,
3. a stabilisation in recovered paper prices.

OCC prices had fallen for four consecutive months, but have stabilised since the start of June and indeed, industry sources are now touting increases, with Asian demand picking up in preparation for Christmas. This is yet another example of the virtuous circle the industry finds itself and given the fact that containerboard price increases are the driving force behind corrugated box increases, gives us confidence around our forecasts for positive pricing momentum to continue into FY11. Therefore, we remain positive on the stock and reiterate our "Buy" recommendation ahead of Q2 results on August 11th.

Strong results from packaging sector keep on coming

Europac is the latest European packaging company to report strong results with EBITDA up over 200% in the first six months on sales up 39%. This implies growth of +360% and 44% in Q2, respectively. Europac is a Spanish based company with over 80% of sales coming from Spain / Portugal / France and is the no.6 player in the European containerboard market (Smurfit Kappa is No.1). Separately, ahead of Mondi's H1 results on August 10th, management has guided that operating profits are expected to be "considerably higher" than last year. In terms of underlying earnings, it is guiding a range of 17-22c versus 8.3c in H109. All the results to date point to a strong performance for Smurfit kappa, who is due to report on August 11th.

Industrial relations issues back on radar

Press commentary this morning highlights that Aer Lingus possibly faces some industrial action over the implementation of its much needed €97m restructuring plan. Back in March, 93% of the cabin crew voted in favour of the restructuring programme, which would have seen flight time increased to 850 hours per year. In the meantime, the airline has got down to the nitty-gritty of implementing the plan. However, differences appear to be emerging in how this would work in practice. It appears now that ballot papers for industrial action were posted to Impact members yesterday and that a ballot will close at 2pm on August 9 next. The ballot is to give approval for industrial action up to and including strike action, but the union appears positioned that initially it will involve a work to rule within existing contracts, whilst the airline is seeking to bring about changes in crew rosters and terms & conditions of employment. The airline last night indicated that it did not anticipate operational disruption as a result of the proposed industrial action. We'll monitor this closely, hopeful that the company is correct and for a speedy resolution, cognisant of the importance of Q3 for the airline. H1 results from the airline are due on August 24 next.

BA Q1 2001 results look better at the pretax level

British Airways (BA) reported a Q1 IMS this morning. It talked about trends in passenger and cargo continuing to be positive with yields up and costs down. Total revenue was down 2.3% in the period, with passenger revenue down 3.4%, after the 11.2% capacity reduction. This implied that yields were up 13.5%. Revenue at £1.937bn came in slightly ahead of the £1.888bn consensus. The airline has faced many disruptions in the quarter - strikes/volcano etc - so it's interesting to see it is saying revenues would have been up 11% only for those. Further, down the P&L, the news is a little better, with an Operating Loss of £72m vs expectations of -£160m. At the PTP level, the airline reported a £164m loss vs consensus of -£196m. While the figures were modestly better, in terms of outlook, the company indicated that it is sticking with its target to break even at the profit before tax level for the full year. So here is another airline with reasonable revenue trends.

Fitch highlights funding challenge for Irish banks, but manageable

Fitch yesterday produced its semi annual tome on the Irish financials, however, here are a few highlights. In probably no surprise, funding is identified as the largest challenge and there is uncertainty how the banks will refinance when the blanket guarantee scheme ends, but overall, Fitch considers the funding situation "manageable", helped by the extension of the less comprehensive guarantee scheme until the year end and access to ECB funding. Fitch says the banks are likely to continue to need a state guaranteed funding scheme in the future and it anticipates that the European Commission will approve the renewal in December of the Eligible Liabilities Guarantee Scheme.

Elsewhere, Fitch highlights weak profitability this year particularly due to NAMA transfers and also highlights that profits will be impacted by restructuring charges. On the latter point, the revenue decline at the banks is making it inevitable that the cost lines will have to be tackled in a comprehensive fashion across the system. For 2011, Fitch is forecasting a significantly better yoy performance, but still muted. Presumably this reflects substantially lower credit losses post the NAMA transfers, but expected continued pre-provision profit pressures at the banks. On the non-NAMA loan book, Fitch expects the rate of emergence of new impaired loans to slow down. The 3 quoted banks - AIB, BOI and IPM - report H1 results in the coming weeks, where the main focus is likely to revolve around the margin/funding outlook.

Italian fallout spreads

Evidence that the recent restriction placed on offshore drilling in Italian waters is having a broad impact both at a corporate and local level can be gleaned from the footnotes within Eni's Q2 results on Wednesday and press commentary within Italy. The restriction, albeit yet to be ratified by Parliament, has led Eni to hold off on a planned sale of Italian assets to Gas Plus pending greater clarity. Such clarity on whether drilling will be restricted within 5 nautical miles of the coast or 12 nautical miles around the perimeter of a marine park should be forthcoming with 60 days of the original 'decree', which was issued at the end of June. Not surprisingly, the Italian media, notably the local variety, has stoked up fears should a similar fate befall the Italian coast to that which has occurred in the Gulf of Mexico. Specific points made in the media range from the contribution of tourism to the economy to the heavy nature of the oil within the Adriatic and the potential for natural disasters such as earthquakes to initiate spills from drilling activity. Notwithstanding the obvious sensitivities around oil spills, the situation as highlighted in our recent commentary is hardly helpful for Petroceltic given uncertainty over its permit application for the Elsa prospect (3.1p contribution to NAV out of a Total NAV of 16.1p) and the timing of rig procurement. In the circumstances, it is hardly surprising that there has been a shift of emphasis back to Algeria (7.5p contribution to NAV) with the commissioning of a rig to commence a four well appraisal programme.

Sitting on a growing mountain of cash

In a quarter when it sold its coagulation business for a $47.1m profit, Trinity Biotech reported a solid set of numbers from remaining operations, recording a 5% qoq increase in diluted EPS to 15.1c despite a 24% reduction in revenue. Operating margins increased by 2.3 percentage points to 15.5%. On the back of these results, we are increasing our FY10 EPS to 55.3c from 47.8c, primarily on margin improvement (14.4% versus 13.2%), as our revenue projections are only moving to $87.6m from $86.0m. Our FY11 and FY12 numbers remain largely unchanged as full margin expansion had already been factored into the model. The monies generated from the divestment leaves Trinity Biotech in a net cash position, while the business also continues to generate considerable cash, throwing off $5.9m in the quarter from operating activities, a 39% improvement on Q209. The company ended the quarter with net cash of $50m, which, when added to the two $11.25m payments due in FY11 and FY12, equates to $3.43 per share (54% of the share price). Management indicated that it is considering the possibility of a share buyback, dependent on the necessary authorisations, which could take five to six months to process. At the current share price, stripping out the cash would see the business trading at 5.2x FY10 earnings, compared to a sector average of 18.1x. Given the solid outturn in a quarter of transition, the upgrades to FY10 numbers, growing cash on the balance sheet and relative valuation, we are comfortable retaining our Buy recommendation.

GPRE Q210 indicate continued traction in the US bio-ethanol market

Green Plains Renewable Energy (GPRE), the fourth largest producer of bio-ethanol in North America, in which NTR currently holds a 37% stake, has reported its Q210 results, which were behind market expectations at the earnings line. Within the results, the key points were:

1. revenues of $453m (vs. $427m in Q110) and ahead of consensus of $429m;
2. net income of $8.7m (vs. $15.6m in Q110), which was modestly behind expectations of $9.3m; and,
3. adjusted EPS of 27c, compared to 3c in Q110 and behind consensus of 31.8c.

During the quarter, over 120m gallons of ethanol were produced and following the completion of its recent expansion programme, GPRE's six operating plants now have an annual capacity of c.500m gallons pa. Accordingly, management noted that this additional capacity will "drive the operating cost per gallon lower" in the forthcoming quarters. In April 2010, GPRE completed the acquisition of five grain elevators in western Tennessee with federally licensed grain storage capacity of 11.7 million bushels, increasing existing storage capacity of the agribusiness segment by 63% to 30.3 million bushels. All of the grain elevators are located within 50 miles of NTR's Tennessee ethanol production facility. While these results were modestly behind expectations, we would view them positively as they illustrate the operational traction which GPRE is gaining in the US bio-ethanol market.