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Beaufort Securities Breakfast Alert: Herenica Resources, Keras Resources, Northcote Energy, Stellar Diamonds, ValiRx, BAE Systems, British American Tobacco, BT, Diageo, Domino's Pizza, Merlin Entertainments, Sky

Published: 17:32 29 Jul 2016 AEST

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Markets
Europe

The FTSE-100 finished yesterday's session 0.44% lower at 6,721.06, whilst the FTSE AIM All-Share index closed 0.39% better-off at 754.19. In continental Europe, markets ended in the red due to losses in banking stocks. Investors digested a mixed set of corporate earnings released yesterday. France’s CAC 40 and Germany’s DAX declined 0.6% and 0.4%, respectively.
Wall Street
Wall Street ended marginally higher, as gains in technology stocks after better-than-expected earnings releases offset losses in telecom and energy stocks. The S&P 500 rose 0.2% in yesterday’s trading session.
Asia
Equities are trading mixed, as the Bank of Japan’s fresh stimulus measures disappointed the markets. The Nikkei 225 added 0.6%, despite the strengthening of yen. The Hang Seng was trading 0.7% down at 7:00 am.
Oil
Yesterday, WTI prices slid 1.9% to US$41.14 per barrel, while Brent oil prices dropped 1.8% to US$42.70 per barrel.

Headlines
Consumer confidence in UK plunges in July
As per the latest survey from GfK, consumer confidence in the UK slumped to -12.0 in July from -1.0 in June, the sharpest m-o-m drop since March 1990. The significant decline was primarily due to increasing concerns about the country’s economic outlook among households and manufacturers after Brexit.

Company news

Herencia Resources (LON:HER, 0.03p) - Speculative Buy
Herencia announced that it completed the sale of Paguanta (zinc, silver, lead project) to an ASX co. Golden Rim. Net of some cash Golden Rim has already paid, Herencia will receive $0.8m today, $0.4m within 30 days and $50k within 60 days. Herencia will also receive $0.8m in Golden Rim equity if a mine is developed at Paguanta.

Our view: The Paguanta sale was dragging on and beginning to look like it might fall over. So this is good news for Herencia which will receive an injection of cash and can now focus on its flagship copper project, Picachos. We have a Spec Buy on Herencia.
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Beaufort Securities acts as corporate broker to Herencia Resources

Keras Resources (LON:KRS, 0.85p) - Speculative Buy
Keras has published a quarterly update from its Grants Patch operation near Kalgoorlie. As a reminder, Keras has three gold projects in Australia, all based on tribute agreements (effectively lease agreements) where Keras does the mining and shares the revenues with the mining rights owner by way of tribute payments. Grants Patch is the first project being mined, next up is the higher grade Wycheproof, which will be followed by Lindsay’s. The longer term plan is to go underground, probably starting at the Prince of Wales deposit. In the period reported, operations were close to break even. Total operating costs were A$1,407/oz versus a gold price of A$1,687/oz however after paying the tribute, total costs were A$1,736/oz. Production was 2,763 ounces.

Our view: This is effectively Keras’ first quarter as a mining company (although the management team has considerable mining experience) and it is proving to be steep learning curve. That said, almost all mining operations have a ramp-up phase / optimisation phase when starting-up. Management expects future quarters to be cash generative as it implements various improvements - increased excavator and trucking capacity (more yellow goods), improved grade control, and renegotiated (lower cost) contracts with service suppliers. Mining is also moving to Wycheproof which has higher grades and a more favourable tribute agreement that Grants Patch. We have a Spec Buy on Keras.
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Beaufort Securities acts as corporate broker to Keras Resources

Northcote Energy (LON:NCT, 0.03p) - Speculative Buy
Northcote published an update focusing on a newly signed gas offtake agreement at Shoats Creek. Enerfin Field Services will buy the gas from wells LM#14 and LM#20. Northcote and its partners must first install gas lines (gross cost $450k) and first gas revenues are expected from LM#14 (52.8% NRI to Northcote) in November.

Shoats Creek is Northcote’s main asset. It is conventional, shallow oil and gas production in Louisiana. The wells at Shoats Creek typically produce light oil and considerable quantities of gas which is currently not being sold. Current sales is oil-only from well LM#20 (where Northcote has a 15% net revenue interest) producing from the Frio formation. The Frio sand reservoir is softer than most (although not unconsolidated) but Northcote’s technical team has a good handle/expertise on its peculiarities. The other main producing formations at Shoats Creek are the Wilcox and Cockfield.

Our view: Gas sales will be a new and very significant source of revenue for Northcote going forward, so this is good news for shareholders. LM#14 (Northcote 53% NRI) will be tied in first for both oil and gas, followed by LM#20 for gas. Once LM#14 is producing, Northcote expects its Shoats Creek net production to increase by c.450%. Looking beyond LM#20 and LM#14, Northcote regards Shoats Creek as a valuable asset and where it plans to focus its resources. Shoats has three producing formations and multiple potential well sites. Regarding new wells, the unknown factors at this stage are funding (self-funded, new equity or RBL?) and working interest/net revenue interest on a well by well basis. Note that apart from the next 2 wells, Northcote has a 50% working interest (37.5% NRI) on all future wells. We have a Spec Buy on Northcote.
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Beaufort Securities acts as corporate broker to Northcote Energy

Stellar Diamonds (LON:STEL, 6.50p)
Stellar has signed earn-in agreements for its Baoulé kimberlite project in Guinea and over two new exploration licences it picked-up in Liberia. The earn-in partner is a Dubai based commodities group called Citigate Commodities Trading. At Baoulé, Citigate will invest $1.5m for 25%, a further $2m to get to 50% and fund a PFS to reach 75%. At the Liberian project phase 1 is $0.25m for 25%, $2m for the next 25% and $4m for a total of 80%. Both these agreements are subject to Citigate completing due diligence.

Our view: Assuming these JV agreements are executed (which we believe is probable) this is a very good result for Stellar. In the current funding environment, Stellar would find it difficult to fund these projects alone, especially now that it is focusing on developing the Tongo project in Sierra Leone. These earn-in agreements ensure Stellar retains significant exposure to both projects without the risk of a cash call.
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Beaufort Securities acts as corporate broker to Stellar Diamonds

ValiRx (LON:VAL, 7.0p) - Speculative Buy
ValiRx Plc, the life science company that focuses on clinical stage cancer therapeutic development, taking proprietary & novel technology for precision medicines towards commercialisation and partnering, yesterday announced that ValiSeek Limited, the joint venture between ValiRx and Tangent Reprofiling Limited has received notification of a New Zealand Patent Grant Allowance. Notification from the New Zealand Patent Office advises that the patent, granted in the US as patent US9072743 on 14th May 2015, has received allowance of grant in New Zealand. This patent covers both the formulation of VAL401 and its use as a treatment against hormone-related cancers, including lung cancer.

Our view: A positive announcement. This is the first non-US patent grant allowance received for the VAL401 project and effectively provides an international validation of the programme to support world-wide commercialisation. ValiSeek was formed to progress the drug through its remaining preclinical development and towards Phase II trials for the treatment of lung cancer and other oncology indications. The SEEK Group, of which Tangent Reprofiling Limited is part, was founded in 2004 and brings safe and low costs medicines to the patients as quickly as possible. It does this by modifying existing medicines to improve their efficacy, by changing the indication but keeping the dose and dosing regime the same or by creating a new medicine when the previous options are unavailable. Yesterday’s news represents another positive for ValiRx and Beaufort retains its Speculative Buy recommendation on the shares.
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Beaufort Securities acts as corporate broker to ValiRx

BAE Systems (LON:BAE, 538.0p) - Buy
BAE Systems declared results for the half year ended 30th June 2016 (H1 2016). During the period, revenue increased to £8,278m from £8,001m in H1 2015. EBITA improved to £849m from £776m in H1 2015. Consequently, profit improved to £418m from £398m in H1 2015, leading to an EPS of 12.9p compared with 12.3p in the same period last year. Order backlog stood at £36.3bn (H1 2015: £37.3bn). Net debt at the end of period stood at £2,036m compared with £1,422m as of 31st December 2015. On the operational front, BAE Systems won a contract worth £118m to build engineering and training facilities in the UK for F-35 Lightning II aircraft. The company was awarded three contracts worth £300m in total to support the UK Ministry of Defence (MOD)'s fleet of Hawk fast jet trainer aircraft until 2020. BAE Systems won a £472m UK MOD contract extension to the Type 26 frigate demonstration phase. In April 2016, Eurofighter partner, Leonardo, signed a contract to supply 28 Typhoon warplanes to Kuwait, which is expected to result in airframe manufacture, capability upgrade and Electronically Scanned radar integration work valued at approximately £1bn for BAE Systems. The company was awarded a £183m contract to provide three gun systems and a trainer for the Royal Navy's Type 26 frigate. The MBDA joint venture, in which BAE Systems has a 37.5% interest, won a number of new orders, of which BAE Systems' share stood at £462m in H1 2016. In July 2016, BAE Systems entered into a 10-year partnership arrangement with the UK MOD, expected to be worth £2.1bn to support the UK Typhoon fleet. The company declared a dividend of 8.6p, up 2% from H1 2015.

Our view: BAE Systems delivered strong performance in H1 2016 despite ongoing political and economic uncertainties. The company recorded higher revenue and profit levels in H1 2016 as demand for its services remained solid. BAE Systems witnessed an increase in military spending in some of its biggest markets, including the US and UK, after a long period of decline. Defence spending was supported by Western military operations against the Islamic State in Syria, Iraq and other locations, and increased Russian sabre rattling. The company secured several contracts in H1 2016 and enjoys a solid order backlog. BAE Systems remains committed to shareholders and increased the dividends payable. The company informed that the UK's decision to leave the EU would create uncertainty, but not impact its near-term business. We believe BAE can secure more high-profile contracts and is well placed with substantial resources and funds to deliver long-term growth. We maintain a Buy rating on the stock.
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British American Tobacco (LON:BATS, 4,782.50p) - Buy
British American Tobacco (‘BAT’), one of the world’s largest tobacco company, yesterday announced its half year results for the 6 months ended 30 June 2016 (H1 2016). During the period, revenue advanced by +4.2% at actual and +7.8% at constant exchange rate basis to £6,669m compared to the same period last year (H1 2015). The increase was due to strong volume performance and good pricing, part offset by the adverse foreign currency movement. On an organic basis, revenue grew at +6%. Due to -2.4% fall in operating margin on a reported basis to 36.8%, along with adverse foreign currency impact, pre-tax profit fell by -2% to £3,426m. Basic earnings per share, benefited from the acquisition and disposal by the Group's associate Reynolds American Inc., has improved by +1% to 143.8p. On the operational front, cigarette volume from subsidiaries increased by +3.4% to 332 billion, or +2.1% organically, driven by strong growth in Asia-Pacific and EEMEA (Eastern Europe, Middle East, and Africa). The volume of its five Global Drive Brands (Dunhill, Kent, Lucky Strike, Pall Mall and Rothmans) expanded by +10.8% and its UK Next Generation Products (such as e-cigarettes) has also grown. BAT’s Chairman, Richard Burrows commented “the business has delivered strong organic growth in the first six months of the year. With profit growth weighted to the second half of the year, we remain confident that we will deliver another year of good earnings growth at constant rates of exchange.” The Group declared an interim dividend of 51.3p per share, up +4%, which will be paid on 28 September 2016.

Our view: British American Tobacco delivered a pleasing result for the first half of 2016, despite the continuing pressure from volatile currencies. Assuming current exchange rates are maintained, the Group expect weak post-Brexit Sterling will create +4% translational tailwind for operating profit, while also contributing a -6% transactional headwind, for the full year. BAT increased share in its key markets (represent over 75% of the Group's volume) by +0.3%, through strong volume growth from Global Drive Brands. Its Next Generation Products also performed well with Vype now available in six markets, and iFuse, its first tobacco heating product, performing ahead of expectations in Bucharest, Romania. Having recently completed the acquisition of Ten Motives, a UK e-cigarettes company, BAT has strengthened its access to the traditional grocery and convenience channels in the UK vapour market. The Group continued to make significant R&D investment in Next Generation Products, which currently range from e-cigarette, those containing Licensed Medicinal Products (a nicotine product licensed as a medicine) and Tobacco Heating Products (an electronic device that heats a nicotine-containing liquid into an inhalable vapour). One of Licensed Medicinal Products, Voke, a nicotine inhaler, is plan to be launched in the UK later during 2016. As an increasing number of countries adopt new and various means in order to reduce domestic cigarette consumption, we believe BAT’s continuous investment in transforming its existing product portfolio is correct way to move the business forward. With its Board confidently forecasted “good earnings growth” for the full year along with an increased dividend, Beaufort reiterates its Buy rating on the stock.
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BT Group (LON:BT.A, 414.35p) - Buy
BT Group announced results for the first quarter ended 30th June 2016 (Q1 2017). Reported revenue for Q1 2017 increased 32% y-o-y to £5.8bn. EBITDA surged 24% to £1.8bn and operating profit rose 14% to £930m. Consequently, pre-tax profit increased 13% to £717m. EPS stood at 5.9p, down 3% from Q1 2016. Net debt at the end of the period stood at £9.6bn compared with £5.8bn at the end of Q1 2016. Normalised free cash flow increased to £448m from £106m in Q1 2016. The company has planned significant governance changes to further increase the independence and transparency of Openreach.

Our view: BT has begun FY 2017 positively and remains on track to meet the targets for the year. The company recorded an increase in revenue and profit margins, along with strong cash flow generation. Most of BT’s divisions performed better than Q1 2016. The company made strong progress in the integration of mobile phone group EE, along with business reorganisation. EE performed strongly on both financial and operational aspects. BT plans to roll out further fibre broadband in the coming months as well as 4G through the Emergency Services Network contract. The company aims to make these services readily available and deploy a new generation of ultrafast broadband. We are buoyed about BT’s progress in the quarter and look forward to further developments. Meanwhile, we maintain a Buy rating on the stock.
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Diageo (LON:DGE, 2,192.0p) - Buy
Organic results improved with volume growth of 1.3%, net sales growth of 2.8%, and operating profit growth of 3.5%. Reported net sales declined 3.0% as organic growth in each region and acquisitions were more than offset by adverse exchange and disposals. Operating profit grew 1.6% with organic growth, lower exceptional operating charges and acquisitions partially offset by adverse exchange and disposals. Free cash flow continued to be strong at £2.1 billion, up £134 million on last year. Operating cash flow was £2.5 billion. Basic EPS of 89.5 pence was down 6% as lower exceptional income reduced basic EPS by 6.1 pence. Pre-exceptional EPS increased 1% to 89.4 pence. The board recommended a final dividend increase of 5% bringing the full year dividend to 59.2 pence per share.

Our view: This is a good set of results delivering what Diageo set out to achieve this time last year and demonstrating momentum. This latter point we highlighted when selecting Diageo as one of our Tips For The Year. This better performance reflects the work done to strengthen the big brands through marketing and innovation, as well as expanding the distribution reach. Diageo’s six global brands and the important US spirits business are all back in growth and the Company has seen a significant improvement in the performance of the scotch and beer portfolios. These results position Diageo to deliver a stronger performance in FY17. The Company is confident of achieving its objective of mid-single digit top line growth, and in the three years ending FY19 delivering 100bps of organic operating margin improvement. We retain our Buy stance.
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Domino's Pizza (LON:DOM, 385.90p) - Buy
The Company has issued a strong set of interims for the 26 weeks to 26th June 2016. The UK market continues to underpin growth with eleven successive quarters of double digit LFL sales growth. A successful new opening store programme saw a record 31 (2015: 24) stores opened in the period and average sales per address in new stores is 24% ahead of the same period last year. Domino’s continued the success of digital investment programme in the UK with e-commerce total system sales ahead by 25% with mobile sales up 35% and mobile sales contribute 62% of online sales. Importantly, the Company reports a continued increase in franchisee profitability, with EBITDA performance up from 15.1% to 15.4%. Encouragingly, the Company report improving performances in international businesses with ROI delivering 12.7% like-for-like sales growth. The Swiss mature stores are showing good growth, with like-for-like sales up 11.7%, and progress in new and immature store portfolio. And the German investment performance is in line with expectations. Domino’s provided an update on its Nordic expansion, with a strategic investment of £24.0m to acquire minority interests in Domino's Iceland, Norway and Sweden, and the Company regard this as an exciting opportunity in attractive growth markets to further grow the Domino's brand. Finally, Group underlying operating profit and EPS up by more than 20% and strong operating cash conversion at more than 93% of EBITDA - net debt of £10.9m following £46.6m payments for international investments and £15.3m of share buy backs.

Our view:Another set of excellent figures with outstanding cash conversion, continued growth from potential increase in outlets and international growth and leading e-commerce platform justifies the high rating, but lower than Just Eat: we retain our BUY Recommendation.
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Merlin Entertainments (LON:MERL, 467.0p) - Buy
Merlin delivered its interim results to end-June 2016 yesterday. Group revenue grew by 5.3%, reflecting a strong contribution from new accommodation and attractions and a positive translational impact from non-Sterling earnings, partially offset by a slight decline in like-for-like revenue. Continued growth in LEGOLAND Parks, with revenue up 11.1%, with revenue at constant currency growing by 5.7%, and a further contribution from new accommodation. Midway Attractions delivered 7.1% revenue growth, with revenue at constant currency grew by 5.3% despite a like for like revenue decline of 0.2%, reflecting a strong contribution from new attractions. Like-for-like performance continues to be impacted by a challenging city centre tourist market, with heightened security concerns and the residual effect of stronger Sterling on the London Division. As expected, the Resort Theme Parks Operating Group (‘RTP’) continued to experience lower visitation at Alton Towers following the accident in June 2015. RTP revenues in the period declined by 7.0%; revenue at constant currency was down 9.1%, reflecting a 10.2% decline in like for like revenue offset by a contribution from new accommodation. Half year profit before tax increased to £50m (£49m) as a result of growth in EBITDA offset by an increased depreciation charge related to continued investment across the estate. Adjusted EPS rose by 3.2% to 3.6p, while dividends per share were lifted to 2.2p from 2.1p in the comparable period.

Our view:Much as expected, few surprises, but still an excellent, high quality vehicle. Merlin yesterday detailed a resilient trading performance despite challenging market conditions, a strong contribution from New Business Development, progress against each of the 2020 strategic milestones and continued confidence in its strategic outlook. Having built an exceptional diversified portfolio, management’s focus on delivering shareholder returns makes Merlin one of its sector’s highest quality plays. Based on 2016E earning of 20.2p/share followed by 22.8p the following year, forward multiples of 22.7x and 20.1x (or 12.7x and 11.5x EV/EBITDA) are still not expensive relatively speaking, although shareholders will be aware that a stellar post-Brexit share price performance now leaves only 10% to 15% upside still to go for. Beaufort retains its Buy recommendation on Merlin Entertainments.
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Sky (LON:SKY, 904.0p) - Buy
Sky declared results for the year ended 30th June 2016 (FY 2016). During the period, revenue increased 20% y-o-y to £12.0bn. The UK and Ireland recorded 7% growth in revenue to £8.4bn. Germany and Austria reported a 12% jump in revenue to £1.5bn. Italy registered a 2% rise in revenue to £2.1bn. Operating profit rose 1% to £977m. Adjusted operating profit surged 12% to £1.6bn. Pre-tax profit dropped to £752m from £1.5bn, mainly due to one-off gains from sales of stakes in ITV and the National Geographic Channel in FY 2015. EPS dropped to 39.0p from 79.1p in FY 2015. Adjusted EPS rose to 63.1p compared with 56.0p in FY 2015. Net debt as of 30th June 2016 stood at £6.2bn (30th June 2015: £5.1bn). Sky remains on track to achieve the current synergy target of £200m by 2017 and extended it to £400m by 2020. The company plans to launch an exclusive series of world-leading cookery show MasterChef in Germany. Sky is expanding its European streaming services with the launch of Sky Ticket in Germany, NOW TV in Italy and the NOW TV Combo in the UK. The company would also launch Ultra HD services in the UK and Germany. Sky Kids app is set to launch across Europe following the success in the UK and Ireland. Sky proposed a final dividend of 20.95p, taking total dividend for the year to 33.5p, up from 32.80p in FY 2015.

Our view:Sky performed well in FY 2016. The company expanded its business into new customer segments and markets. Sky developed more products and services to attract new customers. Over the past 12 months, Sky added 808,000 new customers and sold 3.3 million products. The company continued its strong performance in the UK and Ireland, with revenue crossing £8bn. Sky recorded it’s first-ever full-year operating profit in Germany and Australia, driven by a focus on improving customer proposition. The company increased the dividends payable to shareholders, marking the 12th consecutive year of dividend growth. Sky’s focus on operating efficiently and effectively has resulted in lower costs which have allowed it to make investments. Sky has invested in a new range of products in FY 2016, including the high-end Sky Q (links different screens across the home) and the Sky Now TV Combo (offers rolling bundles of internet, phone and pay-TV channels without long-term contracts). The company plans to expand its services across Europe to strengthen its hold in the market. In light of this argument, we maintain a Buy rating on the stock.
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Economic news
UK house prices

As per Nationwide, house prices in the UK rose 5.2% y-o-y in July compared with 5.1% in June. The markets expected a 4.5% rise in prices. On an m-o-m basis, prices increased 0.5% in July against 0.2% in June.
Germany unemployment change
The number of people without a job in Germany dropped by 7,000 to 2.68 million in July, the Federal Labour Agency said yesterday. Economists had forecasted unemployment to drop by nearly 4,000 for the month. The seasonally adjusted unemployment rate remained at 6.1% in July, in line with the market expectations.
Eurozone Consumer Confidence
As per data from European Commission, the Eurozone’s consumer confidence fell to -7.9 in July from -7.2 in June, in line with the preliminary estimates.
Germany CPI
Consumer price inflation (CPI) in the Germany rose 0.3% m-o-m in July, after a 0.1% increase in June, as per the estimates published by Destatis. The markets expected a 0.2% rise in prices. On y-o-y basis, consumer prices increased 0.4%, following a 0.3% increase last month. The markets expected a 0.3% rise in prices.
US initial jobless claims
Initial jobless claims in the US increased 14,000 to 266,000 in the week ended 23rd July, the Labor Department reported yesterday. Economists expected the claims to increase to 262,000. The four-week moving average fell 1,000 to 256,500 last week, the lowest level since April.

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