JPM_Europe Year Ahead 2019_watermark

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Mislav Matejka, CFA (44-20) 7134-9741

[e-mail]

Overweight

CHF44.76

23 November 2018

Price Target: CHF55.00

End date: 31 Dec 19

Elodie RallAC

(44-20) 7134-5911 [e-mail] JPMA RALL <GO>

Europe Equity Research

03 December 2018

Top pick – LafargeHolcim Ltd

Following a poor share price performance YTD which struggled on continued earnings downgrades, we think Q3 marked a turning point. We note easy comps ahead while expectations on EMs are looking achievable with improving demand and decreasing pressure from supply as per the conclusions of 2018 edition of Global Cement Insights. In our view, there is potential for meaningful improvement in the cash conversion of the group, particularly on tighter management of working capital and lower financing costs.

Against a bearish investor positioning (12% short interest) and broadly negative sell side recommendations (only 30% buys), we identify a number of potential catalysts between the upcoming CMD, divestments (Indonesia) and easy comps for upcoming results. On our 2019E estimates, the stock looks attractive on valuation on 7.5x EV/EBTIDA and 7.9% FCF yield while our bull case suggests >20% upside from here.

Underweight

113p

28 November 2018

Price Target: 110p

End date: 30 Jun 19

Emily BiddulphAC

(44-20) 7134-5906 [e-mail] JPMA BIDDULPH <GO>

Least preferred – SIG PLC

While the stock is down 35% YTD we continue to see some ongoing earnings risk, meaning we struggle to see the stock meaningfully outperforming our coverage near term, and we remain UW.

While the group appears to be executing well on its turnaround plan, (seeing gross margins rise and debt fall) we remain conscious that consensus estimates already factor in double digit EBIT growth in 2019, despite UK revenues now being high single digit down in Q3 and the key European markets turning small negative. We still need gross margin improvement and operating cost declines to deliver on estimates, with no meaningful competitive pressure on gross margin.

While we subscribe to the group's new strategy, we see execution risk, given that group has been underinvested for some time, while competitors have improved their offering and gained scale advantage, meaning not only is the market in the UK becoming incrementally more difficult, we believe the competitive environment is somewhat tougher.

While current management have worked hard to successfully reduce debt this year, the group remains relatively highly leveraged should a worst case scenario play out in its end markets in the near term.

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Mislav Matejka, CFA (44-20) 7134-9741

[e-mail]

Overweight

€10.35

23 November 2018

Price Target: €14.30

End date: 30 Sep 19

Alexander MeesAC

(44-20) 7742-3681 [e-mail] JPMA MEES <GO>

Europe Equity Research

03 December 2018

Top pick – Applus

Applus is our top pick in continental European Business Services. After a long period of decline, Applus’ Energy & Industry division moved into positive organic growth in Q2 2018. We believe a corner has been turned and forecast 4.5% organic growth in this division in 2019 and 2020, but with risk to the upside in 2020. At the current share price, Applus trades at a c.30% FY1 EV/EBITDA discount to its three larger peers (Bureau Veritas, Intertek and SGS), a discount that we see as excessive given we believe its largest exposure (to oil and gas) has moved from headwind to tailwind.

Good visibility over recovery in oil and gas capex. Of the major testing companies, Applus is the most levered into the oil and gas sector, which made up 39% of revenue in 2017. Capex lags crude price movements and historic trends in the price of crude lead us to see the recovery in demand for Applus’ oil and gas testing services as sustainable for the next two years at least.

Resilience in core automotive business. We regard Applus’ other major end market, statutory vehicle inspection, as resilient to variations in economic activity. Applus conducts inspections across nine countries and 83% of its revenue in this division was regulated in 2017. Ongoing technological innovation and regulatory change underpins robust demand growth.

Underweight

€19.17

23 November 2018

Price Target: €20.00

End date: 30 Sep 19

Alexander MeesAC

(44-20) 7742-3681 [e-mail] JPMA MEES <GO>

Least preferred – Bureau Veritas

While we see Bureau Veritas as well-positioned to continue to deliver steady organic growth on the basis of a diverse platform of operations, it is our least preferred in the sector because we see risk to the delivery of its high profile 2020 targets and because it is more highly levered than other TIC companies. Our estimates rely on a recovery in the Marine & Offshore segment, which has been in negative organic growth in recent years and is inherently volatile.

We think the 2020 targets are too ambitious. Bureau Veritas has set itself the target of delivering €1.5 billion of incremental revenue (in constant currency) between 2015 and 2020. We believe it will achieve just €984 million in the absence of acquisitions. It also targets organic growth in the range 5-7%. We believe it will be at 4.1% in 2020, even on the assumption Marine & Offshore accelerates to 5.0%. Bureau Veritas also looks to achieve an operating margin above 17% in 2020. We forecast 16.3%. We suspect that Bureau Veritas will be compelled to revisit its targets during 2019.

Leverage gives less room for manoeuvre. We forecast ND/EBITDA at 2.0x at the end of 2019. This mean Bureau Veritas is more highly levered than its major peers Intertek (1.1x) and SGS (0.5x) and even Applus (1.6x), which may give it less scope for M&A to help it get near its 2020 targets.

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Mislav Matejka, CFA (44-20) 7134-9741

[e-mail]

Overweight

€73.90

23 November 2018

Price Target: Skr98.00

End date: 31 Dec 19

Andrew WilsonAC

(44-20) 7742-6332 [e-mail] JPMA AWILSON <GO>

Underweight

€42.69

23 November 2018

Price Target: €33.50

End date: 31 Dec 19

Glen LiddyAC

(44-20) 7134-4570 [e-mail] JPMA LIDDY <GO>

Europe Equity Research

03 December 2018

Top pick – Epiroc

We continue to see Epiroc as the quality play on a mining recovery. The asset has demonstrated through-cycle organic growth ahead of the sector average, at premium margins and returns and retains the balance sheet optionality to supplement underlying earnings momentum. We see the combination of a quality asset in still recovering end markets, underpinned by balance sheet optionality as attractive in 2019 especially post the recent share price weakness.

Epiroc is a quality asset. As part of Atlas Copco prior to the spin, the Epiroc assets delivered average organic revenue growth of ~8% versus the sector at ~3%, whilst delivering premium margins and returns. We attribute this to the attractive characteristics of Epiroc's market niche and business model.

Well positioned in an attractive end market. We see still good momentum in mining demand with Epiroc set to continue to benefit from its market position, opportunity in replacement equipment and market-leading aftermarket franchise.

Q3 disappointment a short-term issue. Recent share price weakness followed a weaker Q3 order intake, disappointing high expectations. We see this as seasonality and large order timing issue rather than a change to underlying activity. We expect 2019 to see order momentum re-established.

Valuation attractive post recent weakness. The shares currently trade on a 2019/2020 EV/EBITA of 10.4x/9.0x, a discount to our large cap coverage.

Least preferred – Kone Corporation

Downside risk to forecasts: In keeping with prior years, management has not yet provided any guidance for next year, this will come in January with the publication of the full year results for 2018. It should not be overlooked that trading has been challenging in recent months. While OE prices have increased in recent quarters we believe at yet they have failed to compensate for the rise in raw material costs. Next year in China, we expect intense price competition between the international elevator companies to continue given the lack of market growth and a push by some players to gain market share. This, together with the prospect of an ongoing raw material price headwind, results in downside risk to consensus margin expectations in our view.

Expensive given the lack of earnings growth: Kone is one of the more expensive stocks in our industrial universe, trading on EV multiples >40% above the sector average. While we recognise the group has had very strong cash generation for a number of years, earnings growth at Kone between 2017 and 2020E looks set to be a pedestrian 5% which compares with 35% for our industrial universe.

Price target: Our target price is based on our 2020E estimates and a forward EV/EBITA multiple of 12.0x. This multiple is broadly in line with the long-term historical average for Kone and around a 10% premium to the average for our large cap industrial universe.

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Mislav Matejka, CFA (44-20) 7134-9741

[e-mail]

Overweight

€38.40

23 November 2018

Price Target: €48.00

End date: 31 Dec 18

Chetan Udeshi, CFAAC

(44-20) 7742-7034 [e-mail] JPMA UDESHI <GO>

Underweight

€23.92

23 November 2018

Price Target: €24.50

End date: 30 Jun 19

Chetan Udeshi, CFAAC

(44-20) 7742-7034 [e-mail] JPMA UDESHI <GO>

Europe Equity Research

03 December 2018

Top pick – Umicore

Umicore is the leading supplier of cathode material for electric vehicle (EV) rechargeable batteries, provides refining and recycling service for key relevant metals (e.g. cobalt and nickel) and also has EV battery recycling expertise. We are confident on the sustainability of the strong growth and hence the premium valuation of the Umicore stock from the company’s exposure to the EV market.

The company will likely see short-term headwinds from weakening auto demand and lower metal prices. However, given ~30% decline in Umicore’s stock price from the Aug 2018 high, we believe these short-term headwinds are now largely priced in, thus providing a good entry point for midto long-term investors.

Least preferred – Evonik

We see substantial downside potential to estimates in ’19 and beyond, especially on

FCF due to pricing headwinds in commodity businesses with possible additional downside from end demand moderation in other businesses. Despite this downside and weaker cash profile, the stock is trading at a material premium which we see as unwarranted.

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Mislav Matejka, CFA (44-20) 7134-9741

[e-mail]

Overweight

CHF84.64

23 November 2018

Price Target: CHF91.00

End date: 31 Dec 19

Celine Pannuti, CFAAC

(44-20) 7134-7123 [e-mail] JPMA PANNUTI <GO>

Europe Equity Research

03 December 2018

Top pick – Nestle

Our positive stance on Nestle is based on the four building blocks for value creation: 1) top-line acceleration: JPMe 4+% in 2019E-20E; 2) substantial savings: JPMe 18.2% underlying margin by 2020 (in line with management target 17.5-18.5%); 3) portfolio reshuffling, with slower growth and sub-par EBIT margin or ROIC; and 4) balance sheet reinvestments: an additional CHF10bn in SBB leads to c2x gearing by 2020E (vs 1.4x currently) and adds c1% to our EPS CAGR19-20E.

We see 2019 as a turning point for Nestle to deliver on its ambitions of MSD organic growth by 2020. We believe the combination of 1) growth initiatives to grab white spaces, 2) a focus on stronger and faster innovation, and 3) portfolio changes, should boost growth in its core categories Coffee, Waters, Pet Care and Consumer Health close to the market average of 5%. As such we expect organic top-line growth to accelerate to 4.3%/4.5% in FY19/20, with signs of acceleration more evident from Q418 (JPMe 4.5% LFL).

At 18x PE19E ex-OR and 13x EBITDA19E, Nestlé’s valuation discount offers upside for a best in class EPS delivery, top line acceleration along with continued portfolio optionality. Overweight.

Neutral

€48.92

23 November 2018

Price Target: €46.00

End date: 31 Dec 19

Celine Pannuti, CFAAC

(44-20) 7134-7123 [e-mail] JPMA PANNUTI <GO>

Least preferred – Unilever NV

While our top-line growth estimates (4.0% in Q418 and 3.9% in 19E) reflects acceleration over 2018 thanks to pricing and emerging markets recovery, we caution that the margin increase may be under strain from RM costs increase (consensus margin expectations of 70bps increase in H218 vs JPMe 40bps).

Amid lower visibility going into the year end, we believe Unilever premium valuation (20x PE19E, 14x EV/EBITDA19E) vs peers may be under increasing scrutiny. Within European Food/HPC sector, we prefer Overweight-rated Nestlé and Overweight-rated Reckitt which offer better visibility and valuation upside.

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