Broker tips: Dechra, JD Wetherspoon, Imperial Brands, British American Tobacco

Although investors were unimpressed with Dechra's annual results and sent the shares galloping down, analysts at Jefferies liked the "impressive growth" in North America during the veterinary products manufacturer's last trading year.

Jefferies, which reiterated its 'buy' rating and 2,726p target price on the FTSE 250 resident on Monday, pointed to growth of 21.1% globally and a better-than-expected 18.2% sales growth in North America.

Analysts looked fondly on margins expanding "despite some headwinds from increased distributor consolidation and increased investments in sales force" and felt the outlook for 2019 "is positive and signals good progress from recent M&A".

Dechra's North American sales increase was driven primarily by the US but also with strong growth in Canada, where all growth was organic. American operating profit margins remained flat at 32.5%, while sales of Amoxi-Clav, Vetivex and Zycortal were particularly strong despite its Carprofen range being hit by competition with distributors.

In the EU growth of 11.4% came amid benefits from acquisitions as the group exited the contract manufacturing business through the year. Dechra performed ahead of the market in the majority of geographies.

Market dynamics could see further consolidation of distributors, Dechra suggested, with a faster change of veterinary distributors and increased marketing of veterinary distributors' own generic products.

While increased consolidation could see increased buying power of distributors, Jefferies felt Dechra's "high value, innovative portfolio means it is less exposed to these changes and there is value in increasing volumes through consolidated distributors".

Many pub companies are in a "precarious state", Citi warned on Monday, as they have too much leverage and little surplus cash flow to bail themselves out as the increasingly indebted UK heads for a potential disorderly Brexit.

Citi downgraded JD Wetherspoon to ‘sell’ from ‘neutral’, while upgrading Mitchells & Butlers to 'neutral' from 'sell' but only on a valuation basis. Pub companies and restaurant groups were all given a 'sell' recommendation, except for Greene Kingand Restaurant Group, which were seen as 'buy' opportunities also on valuation.

Analysts see two "major risks ahead" from a potentially disorderly Brexit process and the increasingly indebted nature of UK consumers, with the bank's economists expecting up to five percentage points slower growth in GDP over the two-three years following a disorderly Brexit.

"When combined with the increasingly indebted nature of UK households this suggests to us that there could be meaningful downside risks to forecasts."

In the case of Wetherspoon, after recent strong earnings growth has driven the shares higher than peers, analysts assume a normalisation of like-for-like sales growth and modest margin contraction will result in EPS growth to be more in line with the sector in the next five years, resulting in a new target price of 970p that is well below the previous 1,420p.

Big tobacco companies' newfound enthusiasm for vaping threaten the groups' profits, said RBC Capital Markets, leading it to downgrade its rating on Imperial Brands and British American Tobacco.

For both companies, RBC expects next-generation products (NGPs) such as e-cigarettes, which are lower margin than cigarettes, will continue to outgrow the core tobacco business and so lead to a "negative mix effect on profitability".

The pair were both downgraded to 'underperform' from 'sector perform', with the price target for BATS cut to 3,400p from 3,900p and for Imperial to 2,400p from 2,800p, both due to reduced margin expectations.

RBC's research shows that there is "no correlation between the tobacco companies' local market dominance and their high margins".

"We believe their high profitability is down to the industry's historically insurmountable barriers to entry: regulations, economies of scale in manufacturing and the controversial nature of the industry."

BATS plans to get NGPs up to 30% of revenues by 2030, from an estimated 4% in 2018 and RBC does not expect NGPs to reach the same high margins as the combustible cigarette business, "considering the higher fragmentation and lower concentration of the market".

"Therefore such ambitious NGP targets pose a material threat to BAT's profitability," analysts added, assuming a 750 basis point margin decline by 2030.

Imperial said it was stepping up NGP investment, investing £300m this year and by 2020 aiming to have its Blu vaping devices available in more than 20 markets.

Likewise, RBC felt such targets pose a material threat to Imperial's profitability, also assuming a 750 basis point margin decline by 2030.

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