Market Report: Restructuring cost warnings hit Qinetiq

A broker's warning about the costs of an overhaul haunted the defence and security company Qinetiq, which fell back as the wider market struggled to find direction last night.

The stock came under pressure, and retreated by more than 4 per cent, or 6.5p, to 135p after UBS turned negative, arguing that although the company would benefit from a round of restructuring, the change could be "very expensive". The broker said that, faced with a difficult business environment, Qinetiq had a "number of tough choices to make" and investors should "welcome any management action that effectively deals" with the challenging trading conditions.

But while Qinetiq's management has a number of options to size the company to the level of trading in its end markets, its historic cost-to-savings ratio is three-to-one and there is a risk that the restructuring could prove costly in terms of cash.

This raises the prospect of a "cash outflow" which could have "material negative implications", UBS said. "We believe market expectations are too high on earnings, dividends and the prospect of a strategic plan announcement," it added. Revising its recommendation from "neutral" to "sell", albeit with an unchanged target price of 130p, the broker said: "We also believe the market is under appreciative of the likelihood of an equity raising, which is a possibility."

Overall, the benchmark FTSE 100 index came off the boil as traders banked profits from Thursday's gains, retreating by 24.63 points to 5703.02. The mid-cap FTSE 250 index proved more resilient, adding 33.66 points to close at 10223.56 as parts of the retail sector, which were cheered by positive sales figures this week, supplemented their earlier gains. On the FTSE 100, utilities were hit after JPMorgan weighed in on the regulatory debate that is set to dominate the sector as European policymakers worry about the security of energy supplies.

"Pressure on the regulator is more urgent in the UK, where we believe 40 per cent of existing capacity will need to be replaced in the next 10 years," the broker said. "We expect the UK government to encourage low carbon generation, to improve energy efficiency and to provide a more certain return for nuclear investment,"

JPMorgan's analysts said Drax, the coal-fired power station operator which was buoyed by a "buy" note from Royal Bank of Scotland in Thursday's session, as the utility most likely to suffer in this environment. Drax, which was rated "underweight" by JPMorgan, was 12.5p behind at the close, at 370.9p. International Power, which was lowered from "overweight" to "neutral" in the same round-up, fell 12.8p to 316.9p. "Although we believe International Power's diverse generation mix will mitigate some of the risk from the weak power price environment, we still forecast declining earnings in 2010 and 2011," JPMorgan said, setting a 340p target price on the stock. Scottish & Southern Energy also took a hit, falling 24p to 1102p after the broker switched its stance to "underweight", citing the threat of more onerous environmental legislation.

On the upside, Citigroup supported the oil and gas explorer and producer Cairn Energy, which rose 7.2p to 433.9p after the broker increased its target price for the stock to 475p. Citing the potential gains to be had from the company's activities in Rajasthan, India, and offshore Greenland, Citi also raised its net asset value estimate by 14 per cent.

It said Cairn's ambitions to spend up to $800m on exploration in Greenland waters during 2010-11 was a signal of the company's belief in the "transformational potential" of the region.

Elsewhere, the aircraft services group BBA Aviation, which has rallied strongly this month, was 0.5p behind at 197.2p following some bullish broker comment, with Panmure Gordon saying it detected "a sharp improvement" in US air traffic activity in the last two months of 2009.

That bodes well for BBA's Signature business in the US, and could potentially lead to an upward revision of its growth forecasts. "We have detected an 11 per cent improvement in the year-on-year activity trend form the November to December period to the recent February to March period," the experts at Panmure said, repeating their "buy" recommendation.

Higher up, the commercial property group Derwent London rose by 36p to 1362p after Credit Suisse revised its target for the stock from 1052p to 1229p to reflect forecast upgrades prompted by its recent full-year results. "The 2009 earnings result exceeded our expectations, but we still expect 2010 to be down by around 10 per cent year on year, mainly as a result of disposals," the broker said.

Further afield, the publishing and events group United Business Media was 5p ahead at 554p following some positive feedback from a recent investor seminar. "There were no new financials or explicit trading comments, which is no surprise given that the 2009 preliminary results were only a few weeks ago," Panmure said. It added that nevertheless "there was lots of micro data, and some minor key performance indicators, which gives us further confidence in the improving disclosure at UBM".

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