These two sector leaders have serious momentum

With plenty of stocks currently trading at all-time or multi-year highs, investors are right to be sceptical about valuations in some sectors. But any pull back from lofty levels can present buying opportunities, and that’s clearly what’s happened today.

Ferguson (FERG), the plumbing supplies firm formerly known as Wolseley, and sausage roll chain Greggs (GRG) have both been through a rough patch, but there’s been plenty of buying ahead of their most recent updates.

Building materials distributor Ferguson was the best-performing blue-chip Tuesday, up almost 5% to 5,090p, on final results. The £13 billion company had a cracking end to its 2017 financial year and has announced an “expectations-busting” £500 million share buyback.

Underlying operating profit jumped 24% to £1.06 billion, with headline earnings per share (EPS) 23% higher at 289p. Making much of its money in US dollars is clearly a boon, but even at constant current earnings are up 7%. The dividend is hiked 10% to 110p.

The buyback, to be completed within the next 12 months, was two-thirds more than expected and represents 4% of Ferguson’s market cap. Net debt fell 43% to £534 million and management repeated its target of keeping net debt in the range of 1-2 times cash profit, which it says is consistent with investment grade credit metrics.

The disposal of its operations in the Nordic region is “progressing” and the £600-£800 million proceeds should be returned to shareholders. Watch for further news late 2017/early 2018.

Ferguson’s benefiting from “favourable” conditions in US markets, especially in the aftermath of the recent hurricane season and particularly residential and commercial where 89% of its profit is generated. Organic revenue growth at the beginning of the new financial year has slowed slightly to 6% from 8.6% in Q4, but it’s a decent start against a tough comparative.

Shares went from touching a 10-year high 5,285p late March to a 10-month low in just five months, but performed strongly into today’s announcement. The stock’s now back above £50 and analysts are broadly positive, with ‘buy’ ratings all round and target prices ranging from £53 up to £58.

Trading on a forward price/earnings (PE) ratio for 2018 of around 15 times, in line with its historical average, the valuation is attractive, supported by a forward yield of around 2.5%.

Liberum expects a catalyst to come in the form of its e-commerce division, which contributed £3 billion, or 20%, to group revenue. “[We] would expect a re-rating to resume as its own e-commerce strength becomes better understood,” says analyst Charlie Campbell.

Plenty of appetite for Greggs 

Gains at mid-cap baker Greggs are more modest, up as much as 2.5% to 1,281p, after a short but sweet third-quarter trading update. Greggs shares made a 10-month high Tuesday and they’re not too far off an all-time best at 1,369p set in July 2015.

Like Ferguson, its shares have overcome a weak period, hitting a floor below £9 late 2016. Since then Greggs shares are up 40% as it defies lower consumer spending and remains a staple destination for cost-conscious workers and shoppers.

Total sales for the 13 weeks to 30 September were up 8.6%, compared to 5.6% in the same period last year. Year-to-date, total sales are up 7.8%. Investment into Greggs’ new forecasting and replenishment systems are now starting to drive top-line growth, says Investec analyst Alistair Davies. That said, wastage levels are higher, which will impact margins, though this should improve over the medium term.

Full-year expectations are unchanged, Greggs tells us, with food ingredient cost pressures still a headwind.

Again, analysts are positive, with UBS’s Heidi Richardson hailing Greggs’ consistent delivery of growth against an uncertain UK backdrop as “testament to the strength and opportunities of the business”.

Davies moves his target price up 10% to 1,350p, in line with Richardson’s, and sees Greggs as “a multi-year roll-out growth story”.

A forward PE of 18 does not appear particularly cheap, but profit growth forecasts are encouraging, and the ‘buy’ case is backed by a strong balance sheet and prospects for sustainable double-digit total shareholder return, according to Investec.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.