Davy forecasts put growth for Irish economy below that expected by the Government or the troika

Stockbroking firm, Davy’s predictions for the Republic’s economy for next year are a little more subdued than those of either the Government or the EU-IMF Troika.

At an end-of-year briefing yesterday, the company’s chief economist, Conall Mac Coille, predicted that gross domestic product (GDP), a measure of the wealth generated by the economy, including multi-nationals, would increase by 0.2 per cent this year and 0.9 per cent in 2013.

His forecast for next year is below that of the Department of Finance, which recently pitched it at 1.5 per cent, or the EU-IMF troika, responsible for the 2010 bailout of the Republic, which believes that it it will be 1.1 per cent.

In general terms, he believes that domestic demand in the Republic will shrink again next year.

Even though house prices have fallen by about 64 per cent from the peak, and affordability is back at levels similar to those of the 1990s, he suggests that residential property values could dip a bit further in 2013.

At a global level, Mac Coille’s colleagues, Robbie Kelleher and Brian O’Reilly, say that, in terms of the main trends, there will be little or no growth in the euro zone as a whole.

They argue that the developed world’s problems will leave it with a growth rate of just over 1 per cent, lagging emerging economies, where China will lead the way with an 8 per cent expansion.

On specific investment performance, Davy has singled out a number of stocks it believes have the potential to outperform next year. Head of research, Barry Dixon, says that these have a number of characteristics in common.

The first is an ability to grow revenues regardless of the general economic environment, either through a technology advantage, market strength or an exposure to higher growth markets.

The second feature is that the companies have strong balance sheets and the ability to generate cash that can be used to support activities likely to boost their value, including dividend payouts, acquisitions and share buy-backs.

The third is an ability to generate returns on capital above its cost and create long-term economic value, something for which investors are looking in the the current climate.

Associated British Foods

Dixon says that this is fundamentally a play on Primark, a brand already really familiar to Irish shoppers and throughout Europe.

It is already well established here and in Britain, and is proving highly successful in Spain.

More recently, Dixon says that it has become something of a “phenomenon” in Germany and is planning to cash in on this through a fairly aggressive store opening programme.

On the actual food side of the business, Davy points out that the group is set to benefit from the extension of the EU sugar regime beyond 2015, resulting in higher prices for a longer period than the market originally expected.

The stock is currently trading at about 15 times its earnings per share and has a strong balance sheet to support its growth programme.

Frutarom

Dixon says that the Israel-based food ingredients and flavourings specialist is “basically an early-stage Kerry”, and adds that while the Irish group is trading at 16 times earnings, Frutarom is at around 11 times.

The broker says that the company has continued to generate strong growth and cash flows during a period of acquisition and has maintained good financial discipline during this process.

It also appears focused on expanding in the US market, where its expertise in natural flavours and ingredients should give it an edge over rivals.

DCC

While he acknowledges that it is not a stock that immediately springs to mind, Dixon points out that Irish group DCC is one of the biggest fuel distributors in Europe.

He argues that its real strength has been its ability to create value by delivering good returns on capital. His firm points out that the group has consistently delivered a return on capital invested of more than 12 per cent.

Allied to that, it has a strong balance sheet and free cash flows of €120 million, giving it scope to continue expanding through buying up rivals in the European distribution market.

C&C

The drinks group is another Irish stock that Davy believes fits its outperform criteria. After a quiet period, CC put itself firmly back in the headlines recently with its $305 million purchase of Vermont Hard Cider in the US, and then followed it up by buying local operator, Gleeson Group, for €45.6 million.

It is the US that has sparked Davy’s interest. Dixon says that the Vermont deal gives it about 50 per cent of the US cider market, which itself is growing at a rate of about 50 per cent a year. The €100 million cash flows it already generates will help to support that, and it is also poised to benefit from any recovery in its home markets, Ireland and Britain.

Greencore

Exposure to the US should also aid Irish convenience foods group, Greencore, to outperform.

Dixon agrees that the company has not always enjoyed the best of fortunes across the Atlantic, but says that recent partnership deals with coffee chain Starbucks and convenience store operator, 7-Eleven, and the two acquisitions made there this year, are likely to mean a different story.

It is also likely to gain from a strong position in the UK convenience food market, where margins are set to recover over the next two years.

Davy says that the company’s balance sheet is improving, with its debt-to-earnings ratio looking set to fall below three times in 2013.

Smurfit Kappa

Dixon argues that the Dublin-listed international packaging group has “largely resolved” its balance-sheet issues, which are a legacy of its take-private and reflotation, and is heading for an earnings-debt ratio of 2.5 times.

The group looks an attractive bet to Davy on the basis that cash flows are increasing, giving scope for dividend payments to shareholders and/or profit-boosting acquisitions. Smurfit trades around six to seven times earnings, while the average in its sector is closer to 12 times.

William Hill

Two years ago, Dixon says that Davy would have described the bookmaker as a “laggard” in its sector – about 80 per cent of its business still came through the traditional bookie shop.

In contrast, most of its peers, including Irish group Paddy Power, had much more focus on online and mobile.

The firm now believes that its value looks very cheap. The company’s business is now split very evenly between the retail side and online. (It closed or sold what was left of its Irish bookie shops in 2011).

However, it is trading at around 11 times earnings, compared with Paddy Power’s ratio of 23 times forecast 2013 earnings. Davy believes that this discount is likely to narrow next year, presumably as the market realises that the bookie looks a value bet in its sector.

Some other key attractions include the imminent acquisitions of Sportingbet and Playtech. Dixon also points out that it has a strong balance sheet and plenty of cash flow.

Davy nominated Paddy Power in this sector a year ago and, earlier this week, its shares were worth 30 per cent more than the January 2nd closing price.