Investment Column: Reasons to be bullish about LSE's prospects

BlueBay Asset Management; UK Coal
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The Independent Online

Our view: Cautious hold

Share price: 492.5p (-0.75p)

One thing that always happens when the economy emerges from a recession is that markets show signs of recovery before the benefit is felt in the "real economy". That will be good for shareholders of the London Stock Exchange Group, who have seen their investment fall by nearly 70 per cent in 12 months.

The problems facing the company are obvious: it earns money by the value of trades on its markets, and as they have fallen in recent months, so have revenues. IPO work has ground to a halt, and as equities become more toxic, punters have looked at alternative asset classes. Yesterday, the LSE said that revenues on a constant currency basis were down 3 per cent.

Bearish watchers at MF Global advise clients to sell the stock, ascribing a 400p share price target: "Bulls will claim the LSE is a takeover target [but] we fail to see who would be interested in acquiring an exchange facing these enormous challenges," they say.

There are reasons to be bullish, however. The overall revenue numbers actually showed a 4 per cent hike taking into account foreign exchange movements. While IPO activity has waned, secondary issues are soaring: in the three months to the end of December money raised on the LSE's markets was up 145 per cent, to £29.7bn, the second biggest total ever recorded. With companies no longer able to raise cheap debt, and with many having to refinance the excessive cheap debt they have raised, equity financing, and therefore fees for the LSE, is set to jump.

Watchers at HSBC use a complicated way of getting to their price target of 900p: "We divide our return on equity estimate of 16.6 per cent by our cost of equity of 9.2 per cent, calculated using the capital asset pricing model approach, and multiply this by the estimated book value of 474p. We then add our dividend expectation of 26p."

But the company itself concedes that the major risk is the ongoing economic malaise and that, frankly, is not likely to improve soon. Cautious hold.

BlueBay Asset Management

Our view: Sell

Share price: 74.75p (+7.75p)

Analysts at Citigroup described BlueBay's trading statement issued yesterday as "not as bad as feared", adding that the 17 per cent fall of the stock the day before yesterday was due to investors' ultimately misjudged anticipation of a debacle. Sadly for BlueBay, those who jettisoned the stock on Wednesday did not all come back in waves yesterday, despite the shares recovering by a creditable 11.6 per cent.

The group has had an unhappy time of late. Yesterday's update reported that asset under management were down 18.4 per cent since the end of September, with the chief executive, Hugh Willis, conceding that "conditions in global markets continued to be very testing during the fourth calendar quarter of 2008; with unprecedented index declines seen in credit markets". He does cheer the fact that "we saw net outflows over the quarter of only $0.8bn; giving the company overall net inflows of $1.2bn in the July to December period".

Sadly, this will not be enough to add spice to the share price, and Citigroup's assertion that the results are not as bad as expected does not mean that the numbers are in fact any good. The watchers argue that fair value for the group is 80p, based on "a relative price earnings based sum-of-the-parts approach," but sadly the market is reacting on sentiment, rather than anything from a textbook.

Last April, we said sell at 354.25p. It is advice we stand by today. Sell.

UK Coal

Our view: Buy

Share price: 115p (-0.75p)

The UK coal mining industry looks substantially different to how it was 25 years ago: Mrs Thatcher saw to that. However, UK Coal, today the biggest UK producer, claims to be going great guns, despite being exposed to two of the worst-performing sectors of the last few months: mining and real estate. Add to that the fact that the group issued a profits and production warning in October, leading to a 70 per cent drop in the share price over the last 12 months, and investors could be forgiven for being wary.

But it is not that bad. The group's property portfolio has outperformed the market, and production recovered well in the fourth quarter. The market has cottoned on to this, with the stock rising by nearly a third in the last month. Watchers at Evolution do not quite agree with the chief executive, Jon Lloyd, who reckons the share price should be at least double what it is today, but the experts do say that with property assets worth 45p a share, investors can assume that overall value comes in at somewhere between 125p and 170p.

There is momentum behind UK Coal, and so long as it can carry on producing, with legacy contracts in place that protect against falling coal prices, the group is worth a punt. Buy.

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