Must read weekly preview: Barratt Redrow, Babcock, Next, inflation, UK/US interest rates

Barratt Redrow FY – Wednesday 16 September

Richard Hunter, Head of Markets, interactive investor says, “A detailed trading statement in July laid the groundwork for what is likely to be a set of numbers which continues to reflect the difficulties within the housing sector. Barratt Redrow (LSE:BTRW) is of course no exception, and it has refined its strategy to fit the weak backdrop it is currently facing. There had, for example, been some shareholder pressure on Barratts to deploy its capital more effectively, and the company responded with a new £400 million programme. This will comprise a share buyback scheme of £386 million alongside a nominal 1p per share dividend payment totalling £14 million. While the yield will therefore plummet to 0.4% from its current level of 6.2%, the buyback should prove to be price supportive and in addition reflect the group’s currently gaping discount to its net asset value per share.

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The move is another example of Barratt’s ability to move the levers under its control within an incredibly challenging environment. The group had previously announced that one of its strategic options would be to reduce land spend to protect profitability and financial strength. A spend of £625 million compares to £862 million the previous year and is much lower than the £700-800 million recently guided. This has also at a stroke improved the group’s net cash position, which stands at £772 million, in excess of the £550-650 million it expected when reporting in April. 

The use of incentives, which includes but is not limited to a successful part exchange programme, is an effort to maintain buying interest but inevitably puts pressure on margins. Even so, an adjusted pre-tax profit of around £560 million is estimated, which would be in line with expectations and a notable improvement from the previous year.

In terms of outlook, Barratts will inevitably be cautious on the wider environment, and with good reason. Currently, it is difficult to envisage a significant rerating of the sector, which inevitably leads to there being a cap on share price appreciation. The spring and summer selling season was relatively lacklustre, with mortgage approvals down, stifled demand from stamp duty changes and the uncertainty surrounding the housing policy of the new Prime Minister.

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In addition, higher global energy prices and potential supply chain disruption resulting from the conflict in the Middle East, has led Barratt to estimate build cost inflation next year of between 3% and 4%, let alone the impact the war could have on general consumer propensity to buy given the likelihood of higher for longer interest rates.

More positively, and seen through the prism of the long term, there are any number of positive building blocks which should serve the sector, and in turn Barratts, well. There remains a supply imbalance for homes in the UK which will ensure ongoing demand, the government is looking to ease planning regulations, and at some point the estimated trajectory for interest rates will be revised downwards, which should also encourage new buyers. 

In the meantime, Barratt remains a well-run and well-regarded company, although unfortunately this has not been enough to arrest a share price slide which has seen a fall of 18% over the last year and 40% over the last two years, showing the level of recovery required.”

Babcock International trading statement – Wednesday 16 September

Richard says, “Babcock International Group (LSE:BAB)’s full-year results in June revealed that an exceptional charge had punched a hole in profits. The Type 31 frigate programme resulted in a charge of £140 million for the period, caused by a necessary redesign mid-build which, being towards the end of completion, is more complex and therefore more costly. As a result, revenue growth for the year was limited to 8% at £5.18 billion with underlying operating profit declining by 19% to £293.3 million. Underlying operating margin decreased from 7.5% to 5.7% and the charge is expected to have covered most of the remaining rework.

The numbers excluding the charge paint a totally different picture. Underlying operating profit rose 19% to £433.3 million and operating margin of 8.2% exceeded the 8% target set by the group. In addition, underlying free cash flow rose by 71% to £261.8 million, while net debt was reduced from £373.3 million to £329 million. This cash generation enabled an increase to the dividend, although the projected yield remains at a pedestrian 0.8%. But perhaps more notably, a further £200 million share buyback programme comes hot on the heels of the previous £200 million exercise which is now complete.

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The forward contract was healthy at £9.8 billion given a number of contract wins over the period, albeit a touch shy of the £10.4 billion recorded the previous year. 70% of contracted revenue for the coming year is in the bag, where the general outlook has been reiterated, including mid-single digit revenue growth and an underlying operating margin of 9% or greater. Any updates to this guidance will be closely watched.

The pipeline is promising but after a strong run the shares are trading above their longer-term valuation and undoubtedly risks remain. The Type 31 frigate exceptional cost has already had a disproportionate effect on both profits as well as investor confidence. Indeed, the shares have fallen by 23% in the year so far and by 11% over the last 12 months. Even so, the price is higher by 108% over the last two years and there is evidence of investor resilience in continuing to recognise the progress which Babcock is making with the geopolitical backdrop remaining so uncertain.”

Next HY – Thursday 17 September

Richard says, “Expectations will as ever be sky high for Next (LSE:NXT), whose tendency to under-promise and over-deliver has led to an almost guaranteed profit upgrade, while leaving analysts scratching for new superlatives.

The group’s second-quarter update was no exception, with Next breezing past its own estimates and raising its profit guidance for the year as a whole. Full price sales for the second quarter spiked by 9.2%, materially ahead of the group’s 4% estimate, leading to growth of 7.7% for the half-year so far. This translates to £70 million of additional sales, with £19 million coming from the UK and £51 million from overseas. The company attributed the outperformance to warmer weather, the release of some pent-up demand in the Middle East and Northern Europe after a subdued first quarter, and a higher profitable marketing spend. 

Upgrades to Next’s forecasts for the year ride on the coattails of the group’s unswerving momentum. Full-price sales are now expected to rise by 6.3% versus a previous estimate of 5%, total sales by 6.6% (4.6%), with pre-tax profit now pencilled in at £1.24 billion (£1.22 billion).

The group will be mindful of the continuing challenges in the physical retail space, where store sales fell by 1.7% over the six months. However, this was more than offset by strength elsewhere, with UK online growing by 7.4% in that period, and online international by 23.9%, with the latter also reaping the benefit of improved stock availability and more profitable marketing expenditure and both outpacing previous upgrades. 

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In addition, much has been made across the sector of the inflationary impact of higher energy prices from the current conflict which threatens to heighten input costs as well as crimp consumer demand. The group, which has a 6% of overall sales exposure to the Middle East, has responded to the threat by setting aside £47 million for additional costs, although the figure will be offset by savings and price increases elsewhere. Next is nonetheless mindful that should the conflict carry on for an extended period, some suppression of sales would inevitably follow.

Meanwhile, shareholder returns remain another major investor attraction, swinging between share buybacks or special dividends depending on the level of the share price. At present, the share buyback is effectively on hold given the group’s new threshold of £135 per share before continuing with the programme. As such, the pendulum has swung to the dividend, which including specials is currently running on an attractive 4.1% yield and the balance of excess cash will find its way back to shareholders via either route depending on the share price. 

As one of the best run and most respected stocks within the FTSE100, Next finds itself needing to walk the continuous tightrope of becoming a victim of its own success, with expectations for its results being so high. In the meantime, the shares have risen by 28% over the last year and by 113% over the last three years, which is a considerable achievement given the traditional restraints which retail stocks face.”

UK inflation / Bank of England – Wednesday 16 September / Thursday 17 September

Victoria Scholar, Head of Investment, interactive investor, says, “The UK inflation rate looks set to rise to 3.1% for August next week, up from 2.9% in July, partly due to higher road fuel costs. The effects of higher global energy prices from the Middle East conflict continue to contribute towards higher domestic consumer prices.

The Bank of England forecasts inflation will peak at around 3.2% in the fourth quarter. But inflation could push higher than that, depending on how long the conflict lasts and the size of the energy shock. Oil’s recent rally back above $100 a barrel and the escalation of tensions could add further upward pressure to inflation. 

On top of that, base effects in core components will turn unhelpful over the coming months, while the energy price cap will rise in October and probably January too. Food prices also look set to rise this winter because of the very hot, dry weather conditions over the summer in Europe, as well as the Iran war. Offsetting this to some extent is the weak UK economy and jobs market that are reducing the likelihood of major second round inflationary effects and a wage price spiral.

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Although the Bank of England is expected to keep interest rates unchanged at 3.75% next Thursday, there is a growing probability of a 25-basis point hike before year-end, possibly in November as the central bank awaits further inflation clues.

The Bank of England will be keeping a close eye on the United States in the days ahead too, with US CPI on Friday and the Federal Reserve’s rate decision next Wednesday. Analysts are divided over the Fed’s September move, putting a heavy focus on tomorrow’s inflation data. But there’s a growing probability that the Fed will hike next week.”