Broker tips: ARM, Rathbone Brothers, Connaught

The market may have punished ARM's shares after its recent results but Nomura Securities thinks the chip designer had a strong quarter. The broker said the second quarter numbers were encouraging, with underlying dollar revenue coming in ahead of expectations, "as robust licensing offset the seasonal decline in processor royalties." "Gross margin of 94.8% was ahead and with opex [operational expenditure] in line, ARM reported a strong beat," suggested Nomura analyst Dr. Gunnar Plagge. The broker has upped its earnings per share estimate for the current year by 4% on the basis of better gross and operating margins, and has bumped up its price target from 250p to 330p, though it sticks with its "neutral" recommendation. "Freescale's recent announcement to introduce its first ARM-based family of microcontrollers (Kinetis) and the signing of an architecture license with Microsoft last week are in our view both results of customer pull effects coming to the fore at ARM. While the Freescale announcement gives substantial weight to ARM's microcontroller growth strategy, the Intel deal is likely a step towards making Windows (PC version) ARM-compliant and as such substantially enhances the company's addressable market in the mobile computing space longer term," Dr. Plagge postulates. KBC Peel Hunt likes fund manager Rathbone Brothers as a company but it does not like the shares at their current price. "We previously downgraded our forecasts at the start of this month given the level of the equity market on the quarterly billing date of 30 June. Since then, markets have rebounded sharply (+9%) which, if maintained, would leave our forecasts too low. However, we are mindful of continuing volatility which will continue to impact reported results, particularly at the next billing date in September," advises KBC analyst Stuart Duncan. The stock is currently trading on a forward price/earnings ratio of 15.6, compared to a sub-sector average of 11.1. KBC regards Rathbone as "the quality play in the sector" but feels the current valuation offers little upside in the short term. Accordingly, with its price target left unchanged at 745p, the broker switches its recommendation on the stock from "hold" to "sell". The market hates uncertainty and in the case of social housing firm Connaught it may be some time before brokers are prepared to commit to a rating on the company's shares. Numis Securities concedes as much, saying the company's announcement that the exact level of the company debt is "significantly in excess of the previously advised level of £120m" makes valuing the company difficult, particularly in view of concerns that revenues and earnings could be reduced further, notably in social housing. "Anecdotal information from the industry / general marketplace at this time is implying that Environmental is trading well, Compliance is facing some cyclical & integration issues and Social Housing revenue & ebita [earnings before interest, tax and amortisation] could be re-stated downwards (a more rigorous review of WIP [work in progress] and nature of the work - the latter potentially affecting the FOB and secured revenues e.g. tighter definitions of rental income funded response work)," says Numis analyst Francesca Raleigh. "At this time we do not have a target price or recommendation on the shares," the broker said. "Risks include in Social Housing: delays in contract start dates/spend, margin pressure, increased mobilisation costs as contracts become larger & more complex, re-statement of financials and loss of contracts due to under performance; in Compliance: the health of the private sector and SME client base; and as a whole, reputational," Raleigh concluded.