In physics, the observer effect describes how any act of observation will inevitably influence the measured result. Finance journalism has something similar, albeit with the less catchy name of writing-about-fundraisings-before-everything’s-finalised effect (Wafbef).

A lot of companies, you’ve probably noticed, are looking at propping up their cash reserves. The standard process to do this in a hurry is to contact the top 20 biggest shareholders and see if they would be interested in buying some more stock at a discount. This process involves lots of secrecy measures such as wall crossing, but more often than not the wall is a wee bit porous and word of the plan slips into the wider Market.

So it was with DFS Furniture, with the Mail on Sunday revealing over the weekend that a cash call was in the works. DFS confirmed via RNS this morning and then the shares went …… up?

That’s not how these things are expected to go. True, DFS was able to get a long statement out post the MoS report that details the now-familiar playbook of debt, lender grace and cost savings to accompany its 19.9 per cent cashbox. There’s the equally familiar pledge that the cash call will get them through to the other side no matter what, and a line or two about promising current trading though the internet storefront. Nevertheless! The share count will soon increase by nearly 20 per cent via a discounted placing, and investors are viewing that as an opportunity to buy. Hum.

As we said at the open, a lot of companies are in exactly the same position as DFS. (Ben at Betaville names a few possible candidates.) But those companies’ flacks and keepers go into Bodyguard mode whenever a reporter phones up to ask if there are any cash call plans: they will, if required, throw themselves in front of any early report that might smack a share price and be disruptive to the process. Outright lies are justified because the Wafbef Effect was always assumed to be negative.

However, as DFS shows, the correct presentation and can turn the Wafbef effect into a positive. DFS shares have gone up as a direct result of a press leak so the company can now raise more money.

The main takeaway here is that everything is on its head right now. A not dissimilar thing happened to Asos with its cashbox earlier in the month. And out of the last five UK lacings four have been – hallelujah! — priced at a small premium. Maybe, just maybe, other company flacks will remember these examples next time the phone rings and not feel obliged to throw themselves in front of a bullet to save their employer. Maybe.

There’s precious little else of interest in corporate and indexes are meandering lower on nothing much, so here’s a few bits of sellside to pass our time together:

Diageo’s been downgraded both at RBC and Morgan Stanley. The latter’s a big Sector note called “Spirited Away”, which is a cheering reference. Social distancing, global recession and buying cheaper stuff will likely to put pressure on sector earnings for longer than investors expect so they should favour weak beer and strong balance sheets over strong spirits and weak balance sheets, it says. 

A full recovery in 2021 looks unlikely. We anticipate deeper earnings cuts, a slower pick-up in demand, and more downtrading than shares are pricing in. This currently outweighs our positive longer-term view on the sector.

We prefer Beer over Spirits (for now); Overweight Carlsberg. Near-term trends favour Beer over Spirits. Based on our analysis of proprietary AlphaWise surveys, MS global economics forecasts and regional consumption patterns in 2008-09, we expect: (1) lower demand for alcoholic beverages; (2) a consumption shift to off-premise from on-premise; and (3) downtrading, particularly in EMs. In this context we expect Beer stocks with low leverage to outperform Spirits, even though our longer-term preference is for the latter.

Scenario analysis challenges the perception of earnings safety. Our detailed bull/base/bear scenarios yield valuations -40%/-3% /+34% vs current prices, on average. CY21e EPS are ~27% below CY19 in our bear case, and ~4% above in our bull case. That said, we do not envisage major liquidity problems in the sector.

Stock selection framework. We model 2020-21 growth by country / channel combinations, run sensitivities, and assess valuations against DCF and historical relative multiples. In Beer, we build bottom-up LT end-market growth forecasts by country / price-tier. We prefer Carlsberg (Overweight) for its more resilient earnings, LT margin upside / 9% EPS CAGR and strong balance sheet, which we think are not priced in at 19.7x CY21e P/E. Heineken (Equal-weight) comes close, but its superior LT sales growth profile is balanced by near-term downgrades, and 20x CY21e P/E leaves little room for re-rating. ABI’s performance outlook is too uncertain (Equal-weight).

We are cautious on Spirits and rate Pernod Ricard and Diageo Equal-weight, and Remy Cointreau and Campari Underweight. The latter are close to 10YR relative valuation highs (85%/62% premium to EU Bevs), which looks unwarranted, with our FY21e EPS 29%/21% below consensus. The sector appears priced for a quick recovery. On our estimates the sector is trading at 20x CY21 P/E, a +64% premium to MSCI Europe. This is above its 10YR average NTM P/E at 19x and at the top-end of its relative trading range of 20-65% premium. We therefore see limited re-rating potential from here. Spirits (MSe 23x / +85% premium) look particularly vulnerable to a de-rating if a full recovery in 2021 proves elusive.

Where could we be wrong? Key upside risks: effective treatment or vaccine for COVID-19; rapid macro recovery; the off-premise demand surge in March (per Nielsen data) continues; limited trade-down; significant cost-saving moves by our companies. Key downside risks: prolonged downturn; deteriorating EM FX; a longer-term change in consumer habits (e.g. less on-premise consumption).

And RBC goes to “sector perform” from “outperform” on Diageo with a dangling modifier:

In common with the rest of the European consumer staples sector we assume that the cost to compete for Diageo will increase as it spends to boost resilience in case of future shocks. It is no longer appropriate to forecast that Diageo will grow margins faster than other consumer staples companies. Consequently we reduce our price target to £24 and downgrade our rating to Sector Perform.

Once management teams have negotiated the economic consequences of the initial shock of, and recovery from, the coronavirus pandemic we expect them to spend quite a lot of time thinking about the best ways to safeguard the resilience of their businesses. In our view this is going to necessitate additional expenditure – revenue and capital – to ensure that their operations incorporate more deliberate duplication and redundancy than has been the case. We expect Diageo to be as caught up in this trend as anyone else.

Previously we have felt comfortable forecasting above average medium-long term EBIT margin growth for Diageo (+50bps per annum from 2023E-30E compared to +10bps for the majority of our coverage), a function of an effective and consistently applied business model combine with, strong category growth and positive mix trends. We’re no longer convinced, given the opacity of the medium-term outlook and the requirement we anticipate for companies to increase spending in beefing up their resilience.

We now assume that Diageo’s EBIT margin will decline by 10bps per annum from 2023E-30E in common with the rest of the stocks we cover. Reflecting this in our Adjusted Present Value calculation generates a price target of £24, down from £30 previously.

The downtrading trend mentioned above might be happening already, at least based on NABCA US industry data. NABCA is considered a better gauge to demand than Nielsen surveys because it captures everything across 17 states where liquor is regulated, whereas Nielsen just measures off-premise sales. And the general finding is that there was stockpiling of liquor through March but it was cheap liquor. Vodka, American-made “whiskey” and rum have all been selling better versus 12 months ago whereas tequila, Irish whisky and cordials have not. Here’s Credit Suisse to summarise: 

NABCA data shows US Spirits sales grew 17.3% in March, accelerating from 6.6%/5.4% in Jan/Feb respectively. We believe the acceleration largely reflects pantry loading by consumers, and some element of trade loading by retailers ahead of lockdowns. NABCA data measures sales across 17 US states, where distribution is state controlled. The data covers both the on and off-premise channels, representing c20% of total US spirits sales. The strong March growth is in spite of i) Pennsylvania (c15% NABCA sales) closed all stores on 17th March and ii) one less weekend versus last year.

Overall price/mix for the industry was +0.3%, a deceleration from 2.5% rolling 12m, and the weakest in many years. This likely reflects negative channel mix (weak on-premise), package mix (faster growth in larger pack formats) but also some element of downtrading (most apparent in Vodka). The price/mix trends were most negative in Vodka, US Whisky, Rum and Scotch – largely the categories that most improved their volume share trends. Conversely, price/mix trends accelerated across Tequila and Irish Whisky.

Campari, Brown Forman and Diageo have disproportionately benefited from the March pantry load affect, as they have the greatest gearing to the Vodka and US Whiskey category improvements. Pernod’s underperformance is mainly driven by Jameson, as the US lockdowns coincided with St Patrick’s Day, whilst Absolut hasn’t benefited from pantry loading. Remy continues to lose share in Cognac to category leader Hennessy and smaller players such as D’Usse.

IWG, the Regus office owner, goes down to “hold” at Peel Hunt. It forecasts breakeven this year, with very little confidence. 

In such strange times, we have set aside our longstanding model for a new approach. We now use renewal rates and new signings to forecast revenue on a quarterly basis for the next 18 months, to better reflect shape. Revenue could trough in Q4 2020, down 25% from its previous peak LFL, with FY20 revenue down a total of 17% LFL (ameliorated to a 13% decline on a reported basis by maturing centres and new openings).

The GFC comparable: The nearest comparable (our data goes back to 2002) is the GFC. Then, revenue fell by 28% LFL from its previous peak (see charts later). The difference is that in the GFC it took two years for revenues to trough, and required price cuts for another year beyond that to stimulate occupancy. This downturn is different, with renewals likely to start improving earlier, albeit at a slow pace, and still taking time to work through.

Changes to forecasts: We had already trimmed our forecasts over a month ago for the early impact of Covid-19, but now cut them significantly more. We now expect PBT to be at or around breakeven in FY20, and to be only mildly positive compared with previous forecasts in FY21.

Finance: We believe that IWG has already drawn down £600m of its £950m RCF and is now carrying £300m of gross cash (compared with £70m at December 2019) ahead of any possible bank tightening. We now expect ND/EBITDA to peak at 1.3x, well within the covenant of 2.5x, with £100m of EBITDA headroom.

Valuation & recommendation: IWG is trading on c20x FY19, suggesting that it is pricing in a mix of recovery and value release from franchise sales. Such sales had created a lot of value in FY19, and could do again later, but are likely to be subdued for a while. We see 200p as fair value for now, a mix between a normal trading value and the upside from such sales.

Centrica’s down to “reduce” at HSBC.

Centrica has been the worst performer of the stocks in our universe, falling 63% in absolute terms YTD vs the sector index (FTSE Europe utilities), which is down c19%. It has faced a combination of external factors, including a warm winter, low commodity prices and now the COVID-19 outbreak. The lockdown and the company’s inability to sell its upstream assets mean that the recent accomplishment of changing management – with a new chairman and CEO appointed – is one of the few uncertainties it has resolved.

Although Centrica looks to be a good value on many metrics, it offers a complete lack of visibility of earnings from its retail energy businesses for 2020. It has conserved cash by not paying its final dividend for 2019, which together with further savings, has given it cGBP600m of liquidity; we assume working capital requirements could utilise much of this resource. Also, until the lockdown is lifted and upstream is sold, it cannot make the strategic progress needed to drive growth. Our latest survey of retail offerings placed British Gas 42nd in the ranking of retail offerings for a London postcode, implying that it is not able to pass on the commodity price decline to its customers because Centrica has hedged its energy for 2020 at higher prices than its unhedged competitors. Press articles that hint of a possible attraction for M&A (Evening Standard, 14 April), ignore the high level of financial uncertainty, we believe. Given credit metric pressure, we think the board could choose not to pay the dividend in 2020, using the cash as a springboard for growth because, more positively in the medium term, the fallout from the current health crisis may lead to further sector consolidation.

Downgrade to Reduce and cut TP to 28p (from 80p). We value Centrica on a weighted average of three methodologies: DCF (25% weight); dividend yield (50% weight); and DCF and multiples-based SOTP (25% weight) to arrive at our rounded target price of 28p. We increase our target yield to 11% from 6.6% on a reduced 2021e dividend of 3p (previously 5p). In addition, we increase our risk free rate to 2.4% from 2.1%, update our observed beta to 1.4 from 1.0, and increase our additional risk premium from 0.5% to 1% in our DCF valuation. Finally, we reduce our our E&P valuation by c30% in our SOTP approach (lower gas prices), and benchmarking its PE multiple with now what is a premium to Centrica’s historical PE (2019a). These changes result in a cut to our TP to 28p, from 80p, implying c13% downside. We downgrade the stock to Reduce from Hold. Although Centrica’s share price discounts some uncertainties from the COVID-19 pandemic, we believe the market is still not discounting the trading disruption from reduced commodity prices and demand, the likelihood of working capital deterioration, and the bad debt increases – and the resulting pressure that these will have on its credit metrics.

Kepler Cheuvreux isn’t keen on Centrica either:

Centrica’s shares have halved since our downgrade to Reduce at a 79p share price in February (Model down (55pp), 24 February). We continue to see the group as trapped, with downstream operations in structural decline and time running out for planned upstream disposals. We also continue to forecast rising structural pressure downstream and a failure to realise upstream disposals, expecting the recently announced cancellation of the final 3.5p payment for 2019 to morph into a permanent dividend suspension, which we have long forecast and modelled. The group’s operational trap and tight financial situation, as we see it, make a valuation difficult. Greater troubles cannot be ruled out. For the above reasons, we assume a WACC that is three times higher than we assume elsewhere (9% instead of 3% elsewhere and versus the 4% used for Centrica before), which moves our target price down from 70p to 25p. Don’t touch. Reduce.

And HSBC’s not keen on Prudential:

Pru is likely to be stuck in no man’s land until a full separation of its two key businesses, Prudential Corporation Asia (PCA) and Jackson National Life (JNL), is completed. While we believe both operations remain well run and provide exposure to attractive structural trends that should lead to superior growth and returns versus local peers, the market appears unwilling to properly reward this exposure in a single listed entity given negative perceptions about JNL. In our view, it will be difficult to generate value for shareholders without a full separation of PCA and JNL since a minority IPO of JNL alone will not remove asset risk concerns and JNL’s valuation will be constrained by market conditions (lower US bond yields, rising hedging costs and elevated credit risks).

JNL’s identity crisis: JNL has delivered attractive top-and bottom-line growth alongside strong cash remittances across market cycles through effective risk management and its focus on US retirement market opportunities. However, investor concerns are centred on: (i) management plans to diversify into lower ROE business lines to deliver lower hedge costs and higher cash remittances; (ii) M&A is required to deliver the desired business mix within a reasonable timeframe; (iii) a minority IPO is the preferred route for raising new capital to fund M&A but valuations are likely to be underwhelming in the current environment and could be dilutive to existing shareholders; and (iv) JNL asset and hedging risks will remain a concern for Pru shareholders until there is a full separation.

PCA on the right path before uncontrollable events: PCA should be able to deliver double-digit growth across key financial metrics over the medium-term given its product and distribution footprint across underpenetrated Asian markets. Improving NBV growth momentum in 2019 was halted by COVID-19 and instability in HK, but IFRS operating profit growth was robust at 14% in 2019 with c85% of revenues coming from insurance and fee income. Strategically, we expect PCA to consider raising its stake in CITIC-Pru, as well as pursuing further bancassurance deals, regional diversification and focussing on new customer segments, but capacity to fund these ambitions organically may be limited.

We downgrade Pru to Hold with TP of 1,150p (from 1,800p): We continue to believe PCA and JNL are relatively attractive businesses versus peers in their core markets with a good track record of growth, returns, dividends and effective risk management; but investors are no longer willing to reward this combination in a single listed entity, mainly due to asset risks emanating from JNL. It is difficult to see this changing in the near term even with the proposed minority IPO of JNL in challenging market conditions so until management is able to demonstrate value creation from its proposed strategy and with only c10% implied upside to our target price, we downgrade the stock to Hold.

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