Snap up a bargain with Debenhams

Nov 30 2009 By Andrew Miller, The Journal

DEBENHAMS – We have upgraded our recommendation on Debenhams to buy. The retailer, which has 144 stores and £2.3bn in revenue, has some of the cheapest stock in our coverage, with a 10.2x 1-year forward P/E on our 8p estimate.

Our positive view should be seen in the context of our negative view on the European General Retail sector and our expectation that the UK consumer will remain under pressure in 2010.

The company has been focused on increasing its mix to own-bought products and away from concessions so it can better control the quality and value of the product and improve the margin and gross profit.

We think this initiative is under-appreciated in the market and will drive gross margin improvement in FY11 by 65bp, to 43.2% with a minimal impact on sales. Over the longer term, we think Debenhams’ initiatives – including opening smaller sites – will drive shareholder value. The company has also improved its capital structure and we do not believe leverage is an issue. We expect earnings per share to be down next year due to an increased share count but expect PBT to be up 21.5%.

ASTRAZENECA – AstraZeneca’s Q2 results were comfortably ahead of estimates. One of the key reasons was higher-than-expected sales of products that had lost patent protection, but where generic manufacturers had production problems.

However, strong performance from its core portfolio – especially Crestor and its Seroquel franchise – was also a big contributor, as was a significant improvement in its margins, driven by lower costs.

Full-year earnings guidance was raised from a range of $5.15-5.45 to $5.70-$6.00, with sales growth now forecast at mid-single digits.

The good operating momentum, coupled with the raised forecasts, lends support to the current valuation and, in our opinion, suggests that there should be further improvement over the short term.

That said, challenges clearly still remain, with a number of key patents expiring in the next couple of years.

We feel the shares warrant a discount to our targeted sector valuation of 11.5x 2010E earnings, and we suggest an estimate of fair value of 3215p. This drives our outperform recommendation.

PRUDENTIAL – We are retaining our outperform recommendation on Prudential, with an updated fair value of 780p.

Prudential shares have performed well relative to the FTSE Life insurance sector in 2009, driven mainly by a positive response to the full-year results.

At the results, management announced a much stronger solvency position than expected, helped in part by the sale of the Taiwan agency business. The unique Asian franchise remains the source of attraction for Prudential, and the region now produces the majority of new business and Embedded Value (EV) profits.

Although slowing, we expect growth in the region, in particular for insurance products, to be stronger than in the West.

In the UK, growth prospects are limited, but the division is cash generative, as is the group’s asset management division, where investment performance has been strong.

Prudential’s valuation is at a slight premium to the UK life insurance sector, but we feel this is counterbalanced by the superior growth and robust solvency.

Andrew Miller is regional office head of Barclays Wealth in Newcastle