Investment Column: Hikma will be hit by tension in Mid East

Carpetright; Morson
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Our view: Sell

Share price: 834.5p (+30.5p)

hikma pharmaceuticals has had a rough few days. Just two weeks ago, its shares were worth around 900p. But after declining steadily over the course of last week, they were changing hands at only slightly above 800p by the close on Monday. They regained some ground yesterday but Hikma remains well below its January peak.

The losses stem from the unrest in north Africa and the threat of further upheaval in the Middle East. The Jordanian generic drug manufacturer is a leading player in the MENA – Middle East and North Africa – pharmaceutical market, with manufacturing facilities in both Egypt, where there has been unrest for days, and Jordan, which drew headlines of its own after the King sacked the government in the wake of protests over food prices and poor living conditions.

So, how bad can it get? The analysts at Jefferies say that if they assume "that 15 per cent of MENA sales are at risk and decline by 10 per cent in 2011, are flat in 2012 and grow 10 per cent in 2013 before returning to our model growth rates from 2014", then Hikma's sales forecasts would decline by between 1.5 to 2.5 per cent. A tougher scenario where Jefferies applies the same analysis to all of Hikma's MENA sales points to a 7.5 per cent reduction in sales forecasts for this year.

Not disastrous, then, particularly in light of Hikma's longer term prospects. That said, the short to medium term outlook is clouded by the unrest – and by the potential for further upheaval in other parts of the region. Moreover, Hikma's valuation does not help, with the shares trading at a 20 per cent premium to Shire and a 30 per cent premium to Africa's Aspen Pharamacare, according to Numis. Signs that the situation is getting worse will, we fear, trigger further profit taking in this stock, which is up more than 50 per cent since the beginning of last year. Sell.


Our view: Sell

Share price: 707.5p (-22p)

Carpetright yesterday issued a profits warning on the same day that the Bank of England revealed mortgage approvals had hit a 21-month low.

Our view is that the two factors are related, as many people buy a new carpet when they move house. Add to this severe pressure on household budgets and it's easy to see why consumers are shunning big-ticket purchases of carpets, laminate flooring and beds.

Furthermore, Carpetright had hoped for an increased trend towards "improve not move" in the property market. This has also not materialised. Hence, Carpetright warning profits for the year to 30 April will be below market expectations and lower than last year's pre-tax earnings of £28.2m (but ahead of the £17.2m posted in full year 2009). While sales have improved since Christmas, like-for-like sales in the UK and Ireland fell by 7.7 per cent for the quarter to 29 January.

On a rare positive note yesterday full-year gross margin will at least be up by 50 basis points, suggesting the company has at least been able to pass on price rises. However, Carpetright's shares look decidely toppy, trading on a forward earnings multiple of 33.8 times this year and 24.9 for 2012. For this reason, a hibernating consumer and a stagnant outlook for housing transactions, we think Carpetright has further to fall. Sell.


Our view: Take profits

Share price: 113.5p (-6p)

Morson struck us as a good buy with the shares poised at 90p in June. Yesterday's trading statement gives us cause to reconsider. The company specialises in providing technical and engineering personnel and project design help to the aerospace and defence, nuclear and power and rail industries. You can see the problem: quite a bit of its business comes from the public sector. That has been hit hard by the Government's Strategic Defence and Security Review (SDSR).

At least Morson isn't pretending that all is rosy, by contrast to the contracting companies that dismissed the cuts before falling off a cliff. And trading is in line with expectations. But it is still "challenging".

In November, for example, key customer BAE Systems announced it was consulting on 1,300 job losses across a string of UK sites and bases. This followed the cancellation of the Nimrod programme and the early withdrawal from service of the Harrier fleet. More cuts are on the way. Morson is not expensive at just 8.5 times this year's forecast earnings, with a prospective yield of 5 per cent. But, given the outlook, we'd book gains now.