Market update - 25 November

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The FTSE 100 was up 71.74 points at 4224.7 while the FTSE 250 advanced to 5928.84, up 139.29 points, at 11.58am this morning.

Rio Tinto was the weakest on the Footise, falling to 1588p, down 35.18 per cent or 862p, after BHP Billiton, up 16.73 per cent or 164p at 1144p, abandoned its bid to takeover the company. Citing the recent collapse in commodity prices, antitrust requirements and the prospective level of debt at the combined group, BHP chief executive Marius Kloppers said the $66bn offer was no longer in best interests of BHP shareholders.

“We have previously said that similar cultures and the overlap of key assets and infrastructure make this a compelling combination. Recent global events and the associated falls in commodity prices have, however, altered risk dimensions,” he said, adding,

“BHP Billiton is very focused on balance sheet strength. Accordingly, the greater debt exposure of the combination plus the difficulty of divesting assets have increased the risks to shareholder value to an unacceptable level.”

Arbuthnot Securities said the move was “good news for BHP and highlights the amount of debt Rio Tinto took on whet it bought Alcan [the Canadian aluminium producer] earlier this year”. “In a market like this you want to head for quality operators with limited or small amounts of debt,” the broker said,

“Buy BHP [and] sell Rio and Xstrata as both are leveraged. The value of a strong balance sheet in this market is worth more to BHP than the potential benefit of the merger! What does that tell you about debt conditions?”

Liberum Capital also weighed in, highlighting the negative read-across for the wider sector and the potential damage to the credibility of management at both companies.

Liberum analyst Michael Rawlinson said: “We feel neither company has come out smelling of roses. The Rio board have been shown to have bought Alcan at the top [of the market] and been too sluggish in disposing of their assets. BHP under new CEO Marius Kloppers I think has misjudged the ferocity of the anti-trust process. I am not sure either side is sufficiently damaged for heads to roll, but we would guess the CEO at Rio.”

The news pushed the wider sector off the rally path, sending ENRC down 5.84 per cent or 15p to 242p and Antofagasta to 412p, down 4.59 per cent or 19.75p. Lonmin retreated to 820p, down 4.04 per cent or 34.5p, and Xstrata was down 3.4 per cent or 27.5p at 780.5p.

Moving up

Banking stocks continued to draw steam from the US Government’s decision to rescue Citigroup. Standard Chartered, which last night fell back after unveiling a £1.8bn rights issue, was the strongest, gaining 9.59 per cent or 69.5p to 794.5p.

Lloyds TSB, up 9.28 per cent or 13.7p at 161.3p, was just behind while HBOS gained 7.09 per cent or 6.1p to 92.1p.

The Royal Bank of Scotland was up 7.68 per cento r 3.9p at 54.7p after Citigroup issued a “buy” note.

“We believe RBS has sufficient capital to deal with a prolonged economic downturn,” the broker said,

“Assuming this does not develop into a full 1930’s style depression, the company should have sufficient flexibility to complete a thorough strategic review and subsequent restructuring without the need for further recapitalisation or forced disposals.”

Also on the upside, supermarket group Tesco was firm, gaining 4.9p to 304.7p, despite some bearish commentary from Societe Generale.

Reiterating its “sell” recommendation for the stock, the broker said there was a high risk that Tesco may have to resort to a capital raising as its balance sheet comes under pressure.

“Tesco launched a share buyback programme in 2006, with a plan to buy in £3bn of shares over five years and funded a £6.5bn property sale and leaseback plan. To date, the company has repurchased 273 million shares at a total cost of £1.2bn, but with a target of £8bn year-end net debt, there will be no further buybacks for the foreseeable future,” the broker said, adding,

“There are other pressures on Tesco’s balance sheet. Tesco will need to raise a fair amount of debt this year to refinance [previous] debt (£2bn at least) and fund the capital expenditure programme (up £300-400m year-on-year) and share buyback programme (£500m estimated) plus acquisitions (around £2bn). At the same time, we do not expect operating cash flows to rise given higher interest expenses and the potential impact from a price war.”

Moving down

The housing sector was depressed after figures from the British Bankers Association revealed that mortgage lending for house purchases was down 52 per cent in the 12 months to October.

Taylor Wimpey was the weakest, losing 21.43 per cent of 1.5p to 5.5p. Besides the grim report on lending, the stock was under pressure from a new Credit Suisse report on the sector. The broker reduced its target price for Taylor’s shares to 10p from 70p, saying that the trading outlook for house builders remained “extremely poor”.

“We see no grounds for optimism in the underlying housing market,” Credit Suisse said,

“We cite a number of reasons for our unrelenting negative view including deterioration of consumer confidence, continued limited credit availability and increased unemployment while the scale of repossessed properties will likely hinder the new homes market. Despite poor end market demand, we believe that builders will be obliged to aggressively sell product given the requirements to generate cash to service interest payments and de-leverage. This situation would put incremental pressure on selling prices.”