G4S knocked lower by downgrades from Goldman Sachs, Exane

LONDON (ShareCast) - (ShareCast News) - Outsourcer G4S was knocked lower on Thursday as analysts from Goldman Sachs (NYSE: GS-PB - news) and Exane BNP Paribas downgraded the stock the day after results. Looking across a range of brokers, Goldman Sachs cut its rating on G4S (Copenhagen: G4S.CO - news) to 'sell' and Exane downgraded to 'neutral', while Jefferies cut forecasts but maintained its 'hold' rating and house broker JP Morgan took a more sanguine view and reiterated its 'overweight' rating.

Goldman's main negative is that now G4S seemed unlikely to expand margins, even with its growing share of tech solutions, as the sector is now "intensely competitive" due to low barriers to entry and new rivals arriving thanks to software-enabled solutions, while clients face limited costs to prevent them switching to another provider.

"We expected G4S to see pressure from growing capital intensity in developed markets with slower-than-expected growth across its emerging market (EM) exposure." With the company trading at a 13% premium to business services peers, which based on a 2017 estimated multiple of enterprise value over EBITDA that "is not justified in our view, given the weakening free cash flow growth outlook".

On lower estimates, Goldman has a new 12-month price target of 260p.

Exane also zeroed in on the deteriorating EM backdrop, which led it to reappraise G4S's outer-year earnings potential.

"We had previously assumed that the benefits of procurement initiatives would offset EM-related deterioration, to the extent that our micro view on G4S was contrary to our macro views," the French equities broker stated.

The weak EM macro and currency depreciation has capped earnings progression and offset potential positive gains from G4S' strategic improvements.

"Given the inherent late-cyclicality of the industry and the evident, recent deterioration in EM macro conditions, this may intensify," Exane said, cutting 2015-2017 organic revenue estimates to 6% from 8% and trimming its earnings estimates by 3%-10% as higher margins are more than offset by higher forecast minority charges.

Its discounted cash-flow derived target price was correspondingly cut to 290p.

Other brokers taking a dim view included Jefferies, which downgraded its earnings per share forecasts by 4% but maintained its 'hold' saying a strong second half was required and as valuation offers "insufficiently favourable risk/reward relative to history and recovered earnings".

House broker JP Morgan maintained its 'overweight' on G4S however after a good meeting with management, which focused especially on the cost initiatives being pursued, with the margin improvement plan expected to be "a long process and management think there could be at least three to five years of initiatives to work through".