European shares under pressure, while Royal Mail fails to deliver

CMC Markets

The shadow boxing between China and the US has continued this week over when any phase one US-China trade deal may get signed. Despite the cautious optimism of China’s lead negotiator Liu He, it is becoming unlikely that any phase one China trade deal could be signed by the end of this year.

With a presidential election still almost a year away, President Trump is likely to want to keep this particular pot simmering so to speak without getting any worse, for quite a while longer. The unrest in Hong Kong may well give the US president the perfect opportunity to do that if he signs the legislation passed by Congress supporting the Hong Kong protestors.

The surprising cross-party support among all US politicians in standing behind the Hong Kong protestors adds a significant complication to the prospect of any US-China deal, given its insistence for annual reviews on Hong Kong’s special trade status under US law. The bill will also look to sanction any violations of human rights abuses, or any action that undermines the city’s special status.

As concerns about a deal being reached this year recede, markets in Asia have slid for the second day in a row, and as such markets in Europe have also opened lower this morning amid concerns that after six weeks of decent gains, we could see the first negative week for European stocks since the end of September.

This morning the Labour party is set to unveil its manifesto which is expected to call for the nationalisation of a number of utilities including Centrica, Severn Trent and Royal Mail, all of whom are updating the market this morning.

Centrica shares have taken an absolute battering in the last few years, as management have tried and failed to implement a turnaround plan to restore confidence to investors. While there is some evidence of a nationalisation discount most of Centrica’s problems are mostly home grown. The owner of British Gas has been battling a slowdown in revenues and profits, and in the summer the dividend was cut with CEO Ian Conn announcing he was stepping down against a backdrop of 742k customers and a reduction in headcount of 4k.

The company has consistently blamed a challenging environment and this morning’s trading statement doesn’t appear to have changed the outlook for this year. Lower gas prices have been offset by an increase in customer account numbers of 214k with growth of 528k year to date, with losses lower than in the first half of the year. Adjusted cash flow is expected to be in the lower half of the £1.8bn to £2bn range.  Efficiency savings are expected to deliver £300m, compared to a target of £250m, and this has seen the shares rise in early trading.

Severn Trent, who run water services across the South West, including Wales latest first half numbers, have seen the company post a strong first half with turnover up 3.2% to £910m, however underlying profits were down by 4.3% to £286.3m.

Another nationalisation candidate, Royal Mail has had a rough ride of late, its share price dropping below its IPO price just over a year ago, as investors lose faith in the company’s ability to compete with the likes of TNT, Fedex and UPS on a level playing field. There appears to be little sign of an improvement if this morning’s numbers are any guide.

In May Royal Mail cut its dividend in order to free up £1.8bn over five years as management deal with the problems of higher costs on its profit margins. Revenues have continued to grow; however, cost savings have been difficult to achieve and with a pre-Christmas strike potentially just around the corner, there is a sense that things may struggle to improve, unless there is a détente between management, who have clearly made mistakes, and unions, who appear unwilling to adapt to the needs of a 21st century business. 

While revenues have continued to improve, a rise of 5.1%, to over £5.1bn, this morning’s admission that the transformation is behind schedule has seen the share price plunge again, and while the letters division showing its best performance in five years the ability to improve margins is likely to take a little bit longer.

Operating profits showed a fall of 13.2% to £165m for the half year with margins falling from 3.9% to 3.2%, with the biggest fall in profits in its parcel division, a decline of over 33%. Its GLS division in Europe was the best performer, with decent growth in Germany, France and Italy.

On the plus side British American Tobacco is higher on reports that US regulators have shelved plans to cap nicotine levels in cigarettes to non-addictive levels. US officials also appear to be temporarily pulling back from plans to ban flavoured vaping products.

US markets also look set to open lower, following in the footsteps of today’s weaker Asia and European sessions, as investors continue to take profits on recent moves to record highs.

On the earnings front Gap is expected to report its latest Q3 numbers. Earlier this month Gap announced that profits for the current year were likely to come in lower than expected, as well as announcing that CEO Art Peck would be stepping down. Gap cut its full year forecast from $2.05 to $2.15, to $1.70 to $1.75 a share. It also projected that this week’s numbers would come in at about $0.35 a share, a sharp downgrade from the previous $0.55.

The owner of Old Navy and Banana Republic has been struggling in recent months, as it struggles to adapt to changing retail trends. In May the company announced the closure of 130 stores this year, as part of the 230 it intends to close over the next two years The company has also decided to divide the business in two, spinning off Old Navy where the majority of its profitability is derived from, in order to better focus on where it is underperforming. It would appear that despite all of these changes the company still has some way to go before it can consider itself on the right path. This week’s numbers aren’t likely to be too illuminating when it comes to how the company is doing, however they could give us clues as to whether the company is on the right track and whether management is optimistic about Q4.