Broker tips: Melrose, WH Smith, Desire

3rd Dec 2010 13:24

Shares in crisis-torn banknote printer De La Rue are down by a third over the year but up by one sixth in the last week, with the recent good run driven, in part, by rumours of a takeover.One company name in the frame to take over De La Rue is turnaround specialist Melrose, but Panmure Gordon thinks a bid from this source is unlikely, though it would not be surprised if Melrose had taken a look at De La Rue.In short, without "raising material amounts of fresh equity" then Melrose does not have the readies to launch a bid at a knock-out price of 800p per share for De La Rue."A knock-out bid for De La Rue may command an enterprise value of £872m but we can only identify 'comfortable' funding of £695m. Issuing too much new equity would just upset the share incentive plan which matures in May 2012 and which rewards the management team's hard work for turning around FKI. Yes, Melrose could sell some FKI assets but apart from Bridon it looks an immature point to offload the portfolio. FKI assets are also the means to keep the current share price ticking along nicely until May 2012 in order to satisfy the upside for the share incentive plan," the broker said.Melrose is also adverse to taking on further pension obligations, of which De La Rue has plenty. "The deal killer however looks to be De La Rue's pension position. Melrose has a similar stack of pension liability and in our view has to look for solutions first before entertaining further additions (the latter could generate flaws in its buy and dispose model)," the broker suggested.Panmure Gordon rates Melrose shares as a "buy" and has a target price of 340p for the stock.It's tough out there for retailers but newsagent WH Smith's dependence on small purchases should mean it is less affected than most of its high street neighbours by customers looking to cut back on spending, finnCap argues."Its low transaction value should make it more resilient than many retailers if revenues come under further pressure. In any event, it has proved over several years that it can grow profit even as LFL [like for like] sales decline. Its strong financial position and cash generation provide further underpinning, not least through share buy-backs, the latest phase of which we now reflect in our forecasts," said analyst David Stoddart.The broker is forecasting earnings before interest, tax, depreciation and amortisation for WH Smith in 2011 of £131.3m and profit before tax of £92.1m. The adjusted earnings per share forecast is bumped up by around 3.5% to 49.1p from the previous estimate of 47.4p, to reflect the company's share buyback programme.The price target is nudged up to 565p from 550p."The current bad weather will not be good for the Travel division, with stations and airports closed altogether in many areas," Stoddart notes."However, we are not yet reflecting these problems in forecasts. First, they have affected only a few days so far. Second, this might be no more than a timing issue, with less trouble than in the comparative period to come later in the winter. Third, management has devoted considerable attention to making the Travel cost base more responsive to business levels: this should dampen the profit impact of any revenue shortfall in the short term," Stoddart added.The next set of results is due in January. The stock's defensive qualities and the share buyback programme make the shares worth buying in finnCap's view. After the initial disappointment of the first Rachel well and subsequent inability to log its sidetrack, 14/15-1Z, yesterday's announcement from Falklands oil explorer Desire Petroleum "was clearly a welcome development," Westhouse Securities observes. "A second discovery in the basin, following Rockhopper's Sea Lion find, is also beneficial from a development point of view, given the opportunity to share infrastructure across projects. This is particularly important in the case of smaller discoveries which, at this early stage, appears to be the case with Rachel," the broker noted.Westhouse has a new target price for Desire of 142p, based on a smaller resource figure offset by lower risk afforded by the discovery. "Having said that, we have not de-risked the prospect to the extent we have Rockhopper's Sea Lion discovery, given the still limited information available," the broker added.Rockhopper has a 7.5% working interest in the Rachel prospect. Westhouse has adjusted its target price for Rockhopper to 496p, and reiterated its "buy" recommendation.