Irish business lending continues to contract

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1 Davy Research Davy Morning Equity Briefing May Irish business lending continues to contract Stock indices made small losses on Thursday. The Euro Stoxx 50 fell 0.2% while the S&P 500 rose 0.1%. The May issue of Davy Economics Monthly, published today, focuses on two issues. First, the outlook for Irish bank lending to corporates, which has contracted sharply over the recent past the stock of lending to non-financial corporates fell by 6.1% in the year to March Second, we consider how much spare capacity is still left in the UK labour market. Read more Food and beverage ARYZTA: Preview of Q3 IMS, due June 3rd Read more Financials NAMA acknowledges possible surplus Read more Resident banks earned Q1 profits of 215m Read more Results and Events Tuesday June 3rd: Wolseley - interim management statement. ARYZTA - trading update. Wednesday June 4th: Greencore Group - ex-dividend - interim dividend rate - 2.2p. Associated British Foods - exdividend - interim dividend rate - 9.7p. Irish Continental Group - ex-dividend - final dividend rate c. Taylor Wimpey - ex-dividend - special cash p. Voestalpine FY results. Thursday June 5th: Persimmon - ex-dividend - return of capital p. Saint-Gobain Group - AGM - Palais des Congres, Porte Maillot Paris 17, Paris Friday June 6th: Independent News & Media - AGM - The Conrad Hotel, Earlsfort Terrace, Dublin Bellway - interim management statement. Monday June 9th: Petroceltic - EGM - Royal College of Physicians, 6 Kildare Street, Dublin 2. Wednesday June 11th: Saint-Gobain Group - ex-dividend - regular cash c. Betfair FY results. See the end of this report for important disclosures and analyst certification

2 Market Comment Irish business lending continues to contract DAVY VIEW Stock indices made small losses on Thursday. The Euro Stoxx 50 fell 0.2% while the S&P 500 rose 0.1%. The May issue of Davy Economics Monthly, published today, focuses on two issues. First, the outlook for Irish bank lending to corporates, which has contracted sharply over the recent past the stock of lending to non-financial corporates fell by 6.1% in the year to March Second, we consider how much spare capacity is still left in the UK labour market. Conall Mac Coille / Economics Team Conall Mac Coille, David McNamara research@davy.ie Stock indices made small losses on Thursday. The Euro Stoxx 50 fell 0.1% while the S&P 500 rose 0.5%. Markets mainly shrugged off a downward revision to US GDP growth in Q1 to a -1% annualised contraction. A drop in US initial jobless claims in the week to May 24 th to a seven-year low of 300,000 helped to temper any concerns on the health of the economy. In the May issue of Davy Economics Monthly, published today, we focus on two issues. First, although Irish banks have reached their de-leveraging targets, they have not finished their own process of balance sheet repair. This means that Irish banks will be under pressure to gain market share as the pool of credit continues to shrink. This month, we focus on corporate lending, which fell by 6.1% in the year to March Non-property-related lending has fallen back towards 2003 levels, suggesting significant progress in repairing balance sheets. But around 25-35% of Irish banks loans to SMEs and corporates are non-performing, so many companies will not want to add debt in the near future. That said, banks may be able to gain market share as foreign banks exit the Irish market. Similarly, as assets sold by NAMA are re-financed with debt, and institutional investors and private equity exit the market, Irish banks may be able to gain share in commercial property lending. Second, we look at the amount of spare capacity left in the UK labour market. The fall in the unemployment rate to 6.8% has taken the Bank of England by surprise. However, the bank s Monetary Policy Committee (MPC) estimates that spare capacity in the UK economy is close to % of GDP, evenly split between unemployment above its equilibrium rate of 6.0% and additional spare capacity in the labour market. For example, part-time work now accounts for 27%, or 8m, of total UK employment, well up from the 25% average through 1992 to In addition, 18% of part-time workers are seeking full-time work, the highest level in decades, and 36% of temporary workers are looking for permanent jobs. Nonetheless, our view is that labour shortages are now becoming apparent in the UK economy and that wage growth will inevitably pick up. The impact of interest rate rises on CPI inflation takes place with a lag of around months. Hence, we believe that the MPC will start to raise rates slowly, with a first tightening by the end of 2014 in order to contain inflationary pressures over the medium term. 2 Davy Research

3 ARYZTA (YZA ID) Preview of Q3 IMS, due June 3rd DAVY VIEW The like-for-like revenue trend in North America is forecast to improve after poor weather and DSD transition impacted Q2 performance. Food Europe is benefitting from a new operating structure and acquisition contribution (Klemme). FY 2014 guidance of double-digit EPS growth likely to be reiterated (Davy: 397.8c, +10.4% year-on-year). The business is well placed for FY 2015 as ATI completes and recent acquisitions are integrated. The shares have appreciated by c.15% since the interim announcement on March 10 th. Current forecasts place the group on 15x P/E for July 2015 and 10.2x EV/EBITDA. Our model derives a stand-alone Food Group EV/EBITDA of 10.3x for FY We reiterate our Outperform call as the risk/reward dynamic remains favourable. ARYZTA OUTPERFORM Closing price:6635c Cathal Kenny cathal.kenny@davy.ie / Food, Beverage and Pharmaceuticals Team John O'Reilly, Jack Gorman, Cathal Kenny, Declan Morrissey research@davy.ie Share Price Performance Key financials ( m) Solid IMS expected Overall we expect a solid update from ARYZTA when it reports Q3 sales for the Food Group on June 3 rd. Its agri-services division, Origin Enterprises, which is separately quoted, posted a positive trading update on May 28 th, which catalysed a 3% upgrade for the division. We expect full-year guidance of double-digit EPS growth to be reiterated. Davy EPS forecasts are in line with guidance at 397.8c, +10.4% year-on-year (yoy). Food North America volume recovery expected In line with its customer base (in particular QSR), Food North America struggled for volume growth in Q2 (November-January) on the back of a prolonged spell of cold weather. The weather effect is likely to have also impacted the early part of Q3 (February-April) in North America. In parallel, the transition of the Otis DSD business has acted as a drag on organic growth (c.2%) over the past four quarters. For H we model for 2% underlying growth following a modest decline in H1. FX will remain a headwind for the second half of the current financial year we model for a 6% currency headwind. The North American platform was bolstered by the Pineridge (closed April 2 nd ) and Cloverhill (closed March 26 th ) acquisitions. These acquisitions will make a first-time contribution in Q3 FY ARYZTA indicated that the combined revenues of the two acquisitions are some 400m and that they both achieve an operating margin comparable to ARYZTA s Food Group (13.2% for FY 2013). Both are also reported to be exhibiting double-digit revenue growth. In terms of scale, Cloverhill seems much bigger than Pineridge (four-bakery plant). The acquisition contribution underpins our growth forecasts for FY Year end Jul13 Jul14F Jul15F Revenue EBITDA PBT EPS Basic EPS Diluted (Adj) Cash EPS (Diluted) Dividend NBV Valuation P/E FCF Yld (pre div) (%) Dividend Yield (%) Price / Book EV / EBITDA Group Int. Cover (x) Debt / EBITDA (x) Financial Data ARYZTA :Financial model and valuation analysis Speciality baking Sector Review 3 Davy Research

4 Food Europe delivering in a challenging market Food Europe is now exhibiting more stable operating characteristics as the benefits of a more focussed business model play out. Food Europe s renewed focus on delivery is reflected in a new operating structure. In its FY 2013 results presentation, ARYZTA disclosed that its European business would be transformed into two businesses, Food Solutions and Bakery, to align it with customer needs. ARYZTA s European bakery business has slowly repositioned itself in terms of its manufacturing and channel mix. Manufacturing capability and intensity have increased, driven by organic investment (Poland) and M&A (Klemme and Rina). The Klemme acquisition now acts as a fulcrum in Food Europe, strengthening the ISB channel. Organic growth has been positive in four of the past five quarters. For H2 2014, we model for 2% underlying growth following a 1.7% gain in H1 (Q1 +0.7%, Q2 +2.6%). ATI programme nears completion ARYZTA is nearing completion of period of heavy internal investment, which is anchored by the ATI programme. The three-year programme, which commenced in September 2011, should be broadly complete by July. By January 2014, ARYZTA had made an investment of 336m (cash outlay) out of a proposed total cash investment of 460m. In addition to the ATI cash costs, ARYZTA continues to make significant investments in expansion-related capex. The financial goal of the programme is to increase Food Group returns on underlying assets (as of July 2011) to 15%. Since the programme was started, reported returns have increased from 10.2% to 11.5%. As ARYZTA exits the ATI programme, absolute cash conversion will improve. Next week s update will provide more detail with regard to the programme. Through its change programme, ARYZTA is laying the foundations for the next phase of development while creating a more sustainable business model. Across the food sector, unique B2B models continue to demonstrate robust levels of operational delivery. The shares have appreciated by c.15% since the interim announcement on March 10 th. Current forecasts place the group on 15x P/E for July 2015 and 10.2x EV/EBITDA. Our model derives a Food Group EV/EBITDA of 10.3x for FY We reiterate our Outperform call as the risk/reward dynamic remains favourable. 4 Davy Research

5 Banks NAMA acknowledges possible surplus DAVY VIEW Appearing before the Public Accounts Committee, NAMA executives expressed confidence that the agency will ultimately be able to repay its senior and subordinated bonds in full. Addressing recent speculation of a surplus, they acknowledged the possibility but would not be drawn on a figure. Emer Lang emer.lang@davy.ie / Financials Team Emer Lang research@davy.ie Financial Data Banks Sector Review NAMA expects to have repaid 50% of senior bonds by end-2014 Appearing before the Public Accounts Committee (PAC), NAMA CEO, Brendan McDonagh, noted that the Comptroller and Auditor General s report, covering the period), had concluded that the agency should be able to repay its senior debt (originally 30.2bn) in full. He stressed that NAMA s own expectation is that it will be able to pay both its senior (originally 30.2bn, of which 10.5bn has been repaid to date with a further 4.5bn targeted by end-2014) and subordinated bonds ( 1.6bn) in full. In response to recent media speculation that the agency may generate a surplus (of 1bn) he acknowledged the possibility, but stressed that NAMA is not at this stage able to speculate on the potential size of any surplus. He also noted that to achieve its targets NAMA needs to sell c. 6bn of its Irish assets in the period. At the end of 2013, the carrying value of NAMA loans was 19.6bn (net of 4.1bn impairment provisions). 56% of the portfolio is concentrated in the Republic of Ireland, with Dublin accounting for 38% of this. NAMA s key focus is on reducing the state s contingent liability, hence it firmly believes that setting investment return style targets for its performance as recommended by the C&AG is not appropriate, as It is not a long-term fund and setting such targets could impinge on its flexibility. 5 Davy Research

6 Banks Resident banks earned Q1 profits of 215m DAVY VIEW Central Bank locational banking statistics show that Irish resident banks reported net profits of 215m in Q The release highlights the 16% and 26% decline in operating income and costs respectively over the year although this is the first quarter that net profit/loss data is available. As the figures include IFSC banks, their relevance is limited. Emer Lang / Financials Team Emer Lang research@davy.ie Financial Data Banks Sector Review Figures show decline in income/costs, shrinkage in external assets The Central Bank release reveals that resident banks total operating income (interest income, fees and commissions) fell by 16% to 2.5bn while costs fell by 26% to 1.3bn over the year. The bank notes that since Q1 2013, interest income has fallen by 17% while account fees and charges have increased by nearly 19%, albeit from a low base, to 113m. Domestic market banks account for 96% of account fees and charges. Banks also earned 1.3bn of other income mainly interest from bonds and money market instruments and incurred interest payable of 1.9bn. The Central Bank release also shows a 15% fall in resident banks external assets to 359bn (of which the UK is 47%) at the end of the first quarter. Domestic market banks account for 105bn of this. The bank s list of resident credit institutions runs to 68, plus the credit unions, while the domestic market group includes 23 banks plus the credit unions. 6 Davy Research

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