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Adobe

It may look like odd timing to back Adobe (ADBE:NASDAQ) just after lukewarm guidance, but we think this is a great opportunity.

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The creative digital software firm called for fiscal 2024 earnings per share of $17.60 to $18 on $21.3 billion to $21.5 billion revenue, a little light compared with the consensus of $18 and $21.7 billion revenue respectively.

The shares plunged 7%, which seemed harsh to us for a bit of near-term uncertainty, especially given the proven quality of this business. We still strongly believe that Adobe stands out for several clear reasons: its consistently strong financial performance; a powerful balance sheet; exposure to structurally growing markets; and as a great play on AI, or artificial intelligence.

Adobe’s 2024 price to earnings multiple is 32.5, falling below 28 and 25 over the following couple of years as earnings per share close on $24 forecasts. This still might not look especially cheap to many investors, but it is historically low for a business consistently growing way above market averages and delivering 34% operating margins and return on equity. Return on capital employed is 30.9%.

At the end of 2023, Adobe could be sitting on more than $3 billion of net cash. This business is a giant in the creative software space through tools like PDFs, Photoshop, Illustrator, InDesign and Premiere Pro. It is reckoned to own a rough 50% market share. AI is now becoming Adobe’s growth secret sauce, and it has already integrated Firefly into the toolkit, designed to help creatives be more creative.

Ben Rogoff, manager of the Polar Capital Global Technology (B42W4J8) fund and Polar Capital Technology Trust (PCT) has recently admitted bolstering his Adobe positions because its scope to monetise AI is one of the best around.

Adobe’s $20 billion acquisition of rival Figma has been canned after facing regulatory hell. While something of a blow it at least provides a measure of clarity and we believe the company retains its long-run appeal for investors regardless.

To date, 2023 has seen the stock rally more than 70%, tilting the volatility needle, which may not suit every investor. That said, with interest rates looking increasingly like falling in 2024, the market backcloth should be healthier for growth stocks next year.

Analyst consensus has a $700 stock valuation for the next year, and we wouldn’t be at all surprised to see the stock top that in 2024.

Disclaimer: The author of the article (Steven Frazer) owns a personal stake in Polar Capital Technology Trust.

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B&M European Value Retail

Investors seeking a resilient, dividend-paying growth company at the forefront of the consumer trend towards trading down should buy B&M European Value Retail (BME). The variety goods value retailer is benefiting from the cost-of-living crisis.

 

2024 should see the cash-generative discounter continue to capture market share in the UK, where inflation and rising rates have cut consumer purchasing power, as well as in France where sales growth is running at double digits.

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Progressive ordinary dividends and the potential for further special payouts mean B&M is a terrific total return stock to own in an uncertain year ahead.

The budget groceries-to-general merchandise seller retails a range of goods at cheap prices spanning branded groceries and drinks to toiletries, homewares, garden furniture and even toys. Through its core B&M UK fascia, the £6.1 billion cap is gaining market share from a ‘cookie-cutter’ store roll-out and a disruptive, relentless focus on low prices.

The FTSE 100-listed company also owns the expanding convenience store chain Heron Foods and has an exciting overseas growth opportunity via B&M France, where it is strengthening the fast moving consumer goods offer whilst raising store standards.

As Liberum highlights, B&M is ‘a rare case of a retailer that has held onto its Covid gains’ and this has led to ‘a material uplift in sales, and structurally higher margins, profitability and cash generation’. In addition, the retailer’s market shares in the UK and France remain small, meaning there could be many more years of growth ahead.

Following strong first half results in November, B&M upped its year-to-March 2024 adjusted EBITDA (earnings before interest, tax, depreciation and amortisation) guidance to the £620 million to £630 million range, comfortably ahead of the £573 million generated in full year 2023, and B&M highlighted improving sales momentum ahead of Christmas, suggesting scope for good news when the company delivers its third quarter update (9 January).

B&M, which has agreed to acquire as many as 51 ex-Wilko stores from the administrator, also raised its long-term UK B&M store estate target to ‘not less than’ 1,200 outlets, a significant upgrade on previous guidance of 950 and a strong show of confidence from CEO Alex Russo.

Along with continued like-for-like growth, Russo reckons his charge has ‘the runway to at least double our size in the UK in the medium term, while France also offers sizeable long-term potential’. We think investors will profit by backing these growth ambitions.

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Conduit Holdings

Conduit Holdings (CRE) is the parent company of Conduit Re, a Bermuda-based pure-play reinsurance company which launched in December 2020 when the holding company listed on the London Stock Exchange.

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The firm writes reinsurance policies across property, casualty and specialty lines, always making sure its risk is neutral across different sectors and geographies based on an in-depth view of the underlying assets and the specific risk factors.

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Having been established in 2020, the firm has no baggage in terms of ‘legacy’ policies which might come back to bite it, which is a big differentiating factor for investors who are used to buying financial stocks and insurers in particular.

It is this lack of ‘skeletons in the cupboard’, together with the expertise of the management team and the current ‘hard market’ in insurance which makes Conduit Re such an exciting prospect.

According to chief executive Trevor Carvey, it typically takes 18 months for written premiums to flow through to the bottom line, which means the firm is now seeing the benefit of business it took on mid-way through 2022.

To give some impression of how fast the company is growing, it wrote more than $900 million worth of premiums in the first nine months of this year, an increase of 56% on this time last year, and since inception it has written $2 billion with what is called ‘unearned premium’ of $676 million which is yet to flow through to profits.

This means in less than three years the firm has almost hit its five-year target already, Carvey tells Shares.

This is no flash in the pan, however, as the insurance market is going through one of its once-in-a-generation phases of sharply rising rates.

‘Trevor and his team have created a scalable business model and a platform that is delivering strong organic sustainable growth and we have an ample capital base that will enable us to continue to do so,’ says chairman Neil Eckert.

‘We expect the duration of the current hard cycle to be extended due to structural changes in the industry, continued inflationary pressures and adverse development on the industry’s legacy casualty business.’

Analysts at Berenberg agree, calling this a ‘generational opportunity’ across the London reinsurance market, with significant ‘upside risks’ to earnings forecasts in the absence of any major natural catastrophes. Conduit Re has avoided the worst impact of these as most of the risk so far has been carried by the insurers themselves.

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Hollywood Bowl

Ten-pin bowling operator Hollywood Bowl (BOWL) is a super-resilient, cash-generative company whose growth potential in the UK and Canada looks underappreciated by the market based on its current valuation.

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Bowling is an affordable, family-friendly leisure activity with a defensive bent and Hollywood Bowl has scope to beat consensus estimates as robust customer demand, site refurbishments and selective price increases enhance like-for-like sales.

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Even if economic conditions aren’t too favourable people still want the break from the stresses and strains of work and life which a trip to a bowling alley can provide. And a key part of the company’s strategy has involved sprucing up its venues to make them more attractive places to go.

A premium-priced private equity bid for smaller rival Ten Entertainment (TEG) demonstrates the experiential entertainment sector remains significantly undervalued. Once Ten Entertainment delists, Hollywood Bowl, blessed with higher-quality venues, will have scarcity value as the only listed player in an attractive space.

For the uninitiated, Hollywood Bowl is the UK’s largest bowling centre operator with a network of 69 sites and also operates the Puttstars mini-golf brand. While rolling out UK sites organically, the company has a further nine centres in Canada following last year’s Splittsville acquisition.

Despite its status as the UK’s leading bowling centre operator, Hollywood Bowl has fewer than 20% of the nation’s total sites so there is a substantial domestic growth opportunity ahead. Berenberg says the UK footprint has potential to grow to 93 over time, while the count in Canada could grow to north of 40 sites, driving sustainable medium-term growth.

Hollywood Bowl’s business in Canada, a fragmented and underinvested market ripe for expansion, generated impressive 15.1% like-for-like sales growth in the year to 30 September 2023, has ‘excellent’ momentum according to management and should become a much more significant component of group earnings going forward.

Up 4.1% last year, Hollywood Bowl’s UK like-for-like sales have historically beaten market expectations thanks to its compelling value-for-money proposition as well as investments in sites and technology and should continue to grow as the tough economic environment keeps footfall ticking over. Landlords are increasingly keen to bring Hollywood Bowl into new and existing developments as the tenant of choice, so the company’s new sites pipeline should continue to grow.

A strong net cash balance sheet gives Hollywood Bowl the firepower for self-funded growth, acquisitions, dividends and share buybacks. Risks to consider include any future declines in consumers’ disposable incomes or in the popularity of bowling, as well as future challenges in securing new sites at reasonable cost.

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Hunting

Energy services firm Hunting (HTG) is in the midst of a transformation which we think continues to be underappreciated by the market. The company has historically been heavily reliant on US onshore rig activity and is coming to the end of a restructuring process aimed at rebuilding profit after a difficult period in the wake of the pandemic.

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Evidence of its recovery should come through early in 2024 when it reports its 2023 results, and over the course of the next 12 months the company’s efforts to diversify into areas linked to the energy transition should also become more apparent. In our view this can drive a rerating of the shares from a little less than nine times 2024 forecast earnings.

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An investor day in September saw the company make clear the business will no longer be so reliant on its flagship Titan product. This is a perforating gun used to penetrate wells in preparation for production and is mainly sold in the US. In 2019 perforating systems accounted for 37% of group revenue, but in 2023 this is projected at 30% of revenue.

Hunting’s new strategy, which will drive further diversification by geography and product, aims to deliver 15% EBITDA (earnings before interest, tax, depreciation and amortisation) margins by 2025, from the guided 10% to 11% for 2023, with further improvement to come by 2030.

The company hopes to generate $1 billion in free cash flow through to the end of this decade, which should offer plenty of scope for investing in the business and rewarding shareholders with dividends. The company already anticipates being in a net cash position as at the end of 2023.

Hunting sees multiple avenues for growth which should improve the predictability of earnings and result in a more generous valuation from the market.

At present, most of its revenue outside Titan comes from OTCG products (tubes used in oil and gas production) and subsea equipment and technology such as couplings to connect parts of machinery, production risers (the portion of pipeline extending from the seafloor to the surface) and hydraulic valves.

The company also makes electronic parts for the medical, defence and aerospace industries, and plans to bring its engineering expertise to bear in emerging areas like geothermal energy and carbon capture.

Out of a targeted $2 billion revenue in 2030, the company expects at least $250 million to come from energy transition work, and the overall expectation is 25% of its revenue will come from outside the oil and gas market by that date.

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Just Group

Annuities and lifetime mortgage specialist Just Group (JUST) looks screamingly cheap at its current price. We think 2024 will see a rerating from its current low single-digit PE (price to earnings) ratio with the company confident of hitting its 15% underlying operating profit growth target in 2023.

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This profit growth should underpin growth in dividends at a similar level, particularly given the company’s actions to reduce balance sheet risk through interest rate hedging.

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Just Group’s mission statement is to provide competitive products, financial advice and guidance to people in later life. There are growth drivers in the short, medium and long term - not least a growing over-65 population in the UK.

Right now, the company is benefiting from a strong bulk annuities market. Bulk annuities are insurance products which are sold to defined benefit schemes allowing them to transfer their risk, so that the insurance company - in this case Just Group - pays benefits to pension scheme members covered by the policy until they die.

Higher rates have made it more affordable for pension schemes to go down this road and according to Just Group only 11% of total defined benefit liabilities have been ‘de-risked’ this way - which underpins the company’s bullishness on the scale of the opportunity ahead of it.

Consultant Lane Clark & Peacock estimated in 2022 that more than £600 billion of bulk annuity deals would complete over the following 10 years. In a record first half of 2023 Just Group chalked up 35 such deals.

Individual annuities are ‘guaranteed income for life’ products which are bought by people when they reach retirement age. These have become more attractive of late, again thanks to higher interest rates.

Just Group also sells lifetime mortgage products which are effectively a type of equity release product. Any risks associated with exposure to the housing market are mitigated as the average loan to value is little more than 35%.

The shares appear to have fallen out of favour thanks to accounting changes - the new IFRS17 standard means profit on bulk and individual annuities is deferred, making it seem as if earnings have dropped off a cliff. This resulted in a 90% drop in reported 2022 profit and is expected to have a 70% to 80% impact from 2023 to 2027.

However, IFRS17 has zero impact on cash flow, capital generation or the economics of the business. As this becomes more apparent, for example as the company continues to serve up generous dividends, we would expect the market to reappraise the investment case.

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MongoDB

We believe MongoDB (MDB:NASDAQ) could be one of the hottest ways to play another strong year of AI (artificial intelligence) growth in 2024, and many analysts agree. It’s a higher risk play but matched by exciting potential.

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MongoDB is all about massive data; managing, analysing and drawing valuable insights from it. You might think we are already drowning in data but if AI is to deliver on its huge promise, we are going to need more of it? much more. Data is AI’s rocket fuel.

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MongoDB operates a scalable and flexible document database that can handle both structured (spreadsheets, for example) and unstructured data sets (text documents, say). It is hugely popular with software developers because it is simple to learn and use, while still providing all the powerful capabilities needed to meet the most complex requirements at any scale.

It has also become a hit with corporate buying departments, allowing companies to seamlessly tailor the software to their own multi-cloud computing environments in multiple software coding languages.

It is a point not missed by Wells Fargo. Its analysts believe the key to long-term growth is MongoDB’s ability to win new workloads, as ‘every incremental workload has an exponential impact on annual recurring revenue’.

Running AI programmes requires huge amounts of data from which AI can analyse and learn. Take self-driving cars, for example. Not only do they require enormous computing power to assess a multitude of geolocation data points, but they also must constantly assess large numbers of mobile factors - other vehicles, people, animals, weather, and lots more that could affect the car and its passengers.

Since listing on Nasdaq in 2017, MongoDB has consistently smashed growth expectations, firing the stock to gains of more than 1,100%. In its last quarter (to 31 October, its fiscal third quarter), the near-$30 billion company smashed expectations of $406.3 billion revenue at $432.9 billion.

Crucially, earnings did the same, its $0.96 per share blasting past the $0.51 predicted by analysts. That will mean fiscal 2024 (to Jan) will go down as MongoDB’s breakthrough year for positive net earnings. Fiscal 2025 should be even better, with consensus pitched at $270 million of net profit on more than $2.02 billion revenue, implying 22% growth.

Yes, the stock has had a fantastic 2023, more than doubling, but that still leaves the share price far below record $570 levels of June 2021. With net cash of around $600 million to fund further growth, we expect 2024 to be another strong year for shareholder returns.

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Puretech Health

Boston-based biotechnology company Puretech Health (PRTC) has a strong track record of creating value for shareholders.

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Yet its share price languishes more than 50% below a sum-of-the- parts valuation and implies the company’s internal pipeline of assets is worthless, which is far too pessimistic and provides savvy investors with a relatively low-risk buying opportunity.

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Puretech operates a unique, hybrid business model whereby it invests its own capital to develop a pipeline of assets as well as running a ‘Founded Entities’ business for outside investors to provide capital.

Crystallising value in the Nasdaq-listed quoted Founded Entities has allowed the company to fund new projects and return capital to shareholders. These entities have raised $3.8 billion since 2018, of which 96% was funded by third parties.

The most successful entity to date has been Karuna Therapeutics (KRTX:NASDAQ), which has an oral schizophrenia drug KarXT in development. Approval is expected in 2024 and would make KarXT the first new schizophrenia treatment to be commercialised in over 50 years.

Analysts at William Blair estimate KarXT could generate revenue of $2.5 billion a year in the US by 2028, making it a ‘blockbuster’ treatment.

Puretech sold a royalty interest in KarXT to Nasdaq-listed Royalty Pharma (RPRX:NASDAQ). This comprises of an upfront payment of $100 million, up to $400 million in commercial milestones and royalties on sales over $2 billion.

In aggregate, the company has the potential to crystallise $780 million from an initial $18.5 million investment and it still retains an equity interest of $375 million equating to a return on investment of over 60 times.

Liberum believes two more of the company’s clinical-stage assets have unrecognised ‘blockbuster’ potential.

Puretech’s $320 million of cash and cash equivalents on the balance sheet and its stake in Karuna shares, worth around $195 million, add up to more than its current market capitalisation.

Liberum estimates the value of the other founded entities and risk-adjusted value from the firm’s internal pipeline adds up to 370p per share, which means the shares are trading at a 59% discount to intrinsic value, implying 142% upside.

The biggest risk is the shares remain unappreciated and value takes longer than expected to crystallise. This might be a problem for a normal biotech company developing a drug pipeline as financing needs are never far away.

However, this clearly isn’t a concern for Puretech given the huge amount of cash sitting on its balance sheet. This in turn may invite potential bidders for the business and provides another possible exit for patient investors.

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RELX

FTSE 100 firm RELX (REL) is ‘ahead of the game’ when it comes to integrating artificial intelligence (AI) into its business and we think this continues to be underappreciated by the market. We expect that to change in 2024 and this makes the shares a compelling investment for the year ahead.

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RELX takes large datasets and analyses these for clients across a range of sectors as well as publishing scientific journals and research. The latter includes ScienceDirect - the world’s largest platform dedicated to peer reviewed primary scientific and medical research - which has proved to be resilient particularly in times of macroeconomic and geopolitical uncertainty.

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The company has been investing in innovation around data analytics and AI for several years which is helping to reinforce an already strong competitive position. It is also supporting a move from a low-single-digit organic growth rate to mid-single digit growth, with the company’s progress augmented by bolt-on acquisitions.

The company has four separate divisions: risk, legal, exhibitions and scientific, technical, and medical (STM) and enjoys strong recurring revenue thanks to a subscription-based business model.

RELX observes that its products often account for less than 1% of its customers‘ total cost base but can have a significant and positive impact on the economics of the remaining 99%. In other words what RELX charges its customers is a very small proportion of their overall spend but is also really significant to how they do business which helps reinforce the stickiness of its revenue streams.

The application of generative AI is probably most advanced in the legal division where its Lexis +AI product is bringing artificial intelligence capabilities to its existing research platform. This can help lawyers digest complex legalese and conduct useful analysis.

The company’s exhibitions division is running ahead of pre-pandemic levels with a 12% increase in first half revenue with exhibitors now using a growing range of digital tools.

The stock often looks fairly expensive but if you if you’d let a similarly lofty valuation put you off a decade or so ago, for example, you’d have missed out on a total return of more than 300% in the interim or around 15% on an annualised basis.

RELX will continue to develop and incorporate content, higher value-add analytics, decision tools and generative AI across all its segments and the company is well positioned to be beneficiary of the long-term structural growth in this area.

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Smith & Nephew

Tentative signs of sustainable margin improvement and market share gains, combined with the tailwind provided by continued recovery in elective procedures, should provide medical products company Smith & Nephew (SN.) with positive momentum heading into 2024.

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The shares are trading close to 10-year lows, and from a valuation perspective have rarely offered better value relative to the UK market and the firm’s US and European peers than they do currently.

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Analysts at Berenberg estimate the shares are trading on a 2023 PE (price to earnings) ratio of 15 times, which looks stingy compared with three-year expected earnings per share growth of 16% per year.

Also, sentiment should get a boost from the appointment of new chief financial officer John Rogers, the former CFO of advertising group WPP (WPP), who has extensive experience in business transformations and capital markets.

We believe the current depressed valuation offers a buying opportunity which should be rewarded as better operational performance is delivered.

In the medium-term, the firm is targeting more than 5% underlying annual revenue growth and a trading profit margin of over 20%, which would bring it closer to its global peers.

At the beginning of November, the firm raised its full-year sales growth guidance to the top end of the range of 6% and 7% which is encouraging.

At an investor event at the end of November, chief executive Deepak Nath said the company had completed 65% of its 12-point plan (to improve operational performance) compared with 45% at the half-year mark meaning investors should start to see tangible evidence of progress.

One example cited by Berenberg is an improvement in commercial delivery in Orthopaedics (hip and knee transplants) which is leading to market share gains.

There is concern in some quarters that the widespread adoption of weight-loss drugs could reduce the demand for knee and hip replacements, as being overweight is a contributing cause of joint wear.

The chief executive believes the opposite is true. ‘As patients presumably benefit from GLP-1, (a class of weight-loss drugs), you could actually see some of these patients who are previously ineligible for joint replacement become eligible for that surgery,’ observed Nath.

The current senior management team appears to be gaining traction and delivering tangible financial benefits, and Shares thinks the risk of the firm not delivering on the turnaround are already factored into the low valuation.

 

 

 

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