Tate's welcome change of strategy

Nov 16 2009 by Andrew Miller, The Journal

Share Watch with Andrew Miller

TATE & Lyle - We are upgrading our recommendation on Tate & Lyle to outperform.

We strongly approve of Tate’s current direction, namely the reduction of capex and costs and the focus on debt.

Over the group’s most recent investment cycle, the returns on investment have been notably poor.

On average, the group has been spending 2.7 times depreciation on capex over the last four years. Over this period, the group’s return on assets has declined from 20% to 12%.

However, in a welcome change of strategy, capex is now set to be reduced to under 1 times depreciation, which will release significant cashflow in our view.

On our forecasts, the group will have a free cashflow yield of 12% next year. With a new CEO from Reckitt Benckiser, we believe focus on working capital will only increase.

With cashflow and net debt moving in the right direction, there is the potential for Tate & Lyle to be debt free in three to four years.

This, in our opinion, could have positive implications for the dividend policy. Our DCF model suggests a fair value of 525p for the shares. This equates to a 2011 PE of 12.5 times.

GKN – We are upgrading our recommendation on GKN to outperform due to its recovery potential as markets stabilise and costs are cut. As auto markets are fragile, GKN is not for risk-averse investors. But for those able to absorb the risk in an auto supplier, with no income, we think current levels are a good entry point.

Stock performance rests on GKN’s earnings outlook, plus improved confidence in its growth potential. So we see GKN shares moving on auto and economic news. Current global economic forecasts improve confidence in GKN’s outlook we feel. A more stable 2010 auto output is expected, without 2009’s de-stocking, with a better mix for GKN.

It says it did not benefit much from 2009’s scrappage incentives which boosted smaller/cheaper cars. Higher, more stable volumes, with the cumulative effect of extensive cost-cutting support estimates. Off Highway is late cycle, but cost-cutting should help next year. Civil aerospace may worsen, but industry lead times suggest this will not be before H2 2010, if at all. GKN has a bearish stance on its civil outlook (it is budgeting on volumes falling 30%) and identified areas where it will down size. Military aerospace is likely to drop in 2010 as some programmes end before new ones ramp up.

The rights issue addresses funding, albeit diluting its recovery potential. The pension deficit creates a hurdle for valuations, but should be factored in. We estimate fair value at 133p, based on what we see as its medium- term potential and market ratings.

Andrew Miller is regional office head at Barclays Wealth in Newcastle