Week Ahead: ITV | Budget outlook | US retailers

Good morning and welcome to the first Week Ahead of March - a big week for company reporting and British economics.

A budget at the beginning of an election year presents a big challenge for any chancellor. Throw in the fact that the UK has just been formally declared to be in a recession and Jeremy Hunt has his work cut out this week. We’ve already been told not to expect as big a tax cut as the public might have hoped for. But unfunded tax cuts don’t go down well with the market, so investors should probably be relieved that Mr Hunt is slightly more conservative than his predecessor Kwasi Kwarteng.

One thing investors will be on the lookout for on Wednesday is any more detail about a potential overhaul to the ISA tax wrapper, to try and encourage more investment in domestic shares. Speculation about a British ISA - which gives additional tax relief for investments in UK stocks - has been brewing for the last few months, but there are concerns that this would bring more complications than solutions (and complications are the last thing needed to get Brits investing in our own companies).

Looking at the hefty slug of financial results due this week, it’s clear why something needs to be done to stimulate some excitement in the London Stock Exchange. Despite a huge number of companies in the FTSE 350 reporting this week, there is not an awful lot to be enthusiastic about. Craneware and Quartix - two former high flyers in the small caps arena - have reported this morning and we’ll have numbers from Greggs tomorrow. But, there isn’t a lot else that is especially eye-catching.

Across the pond, the most interesting results are likely to come from Costco which continues to deliver incredibly impressive growth. The company has shown that it benefits from many different economic environments - with sales of cheaper, unbranded goods fuelling demand during inflationary periods and bigger ticket, discretionary items helping support the numbers when the economy is strong.

Announcements to look out for this week

ITV: Is there further to fall?

ITV (LON:ITV) shares aren’t at an all time low - but they sometimes look like they’re heading there. From a peak of 270p in 2015, the price has halved in the last five years and is now sitting at a lowly 68p per share. That gives the company a market capitalisation of £2.9bn, which is lower than the annual sales that it is expected to report on Thursday 7 March.

But despite a relatively resilient revenue performance amid a turbulent market, the collapse in ITV’s share price is not unwarranted. Profits have stumbled in the media and entertainment division as demand for television advertising has dropped, while the company’s share of the British TV-watching audience has fallen from 60% in 2016 to less than 50% today.

Meanwhile, the studios business continues to face intense competition from international film and TV producers with far deeper pockets. And these in turn are fighting for eyeballs amid a change in demand for content, especially among younger audiences. Creating content is expensive meaning and ITV plans to pump over £1.35bn into new programmes and formats every year. But that is a drop in the ocean compared to the investments being made by the likes of Netflix and Amazon. And profits in the studios business remain meagre, meaning the slight increase booked in the last couple of years has not been enough to make up for the declines in the media and entertainment section of the business (which relies on advertising).

Still, change is afoot.

Last week, the company announced the sale of its 50% stake in Britbox (the streaming service it has owned with the BBC) for £255m in order to allow the company to focus on ITV X - its own advertiser-funded streaming platform. Net proceeds from the sale (worth about £235m) will likely be returned to shareholders via share buybacks, due to be announced following the results this week.

ITV isn’t strapped for cash and gearing remains at a comfortable level, but investing in buybacks still seems a strange choice. Surely there are other areas of the business which could do with investment to stimulate some new growth. Still, shareholders seemed to like the announcement, sending the share price up 15% last week - a welcome relief after a tough few years.

There is an argument to be made that the shares are materially undervalued. Trading on 7.5 times forecast earnings is tempting entry point compared to its history. And compared to peers in the industry, ITV looks like a steal. French studios business FL Entertainment has an enterprise value (market cap plus net debt) of £5.7bn and last year reported €670m of adjusted operating profits (an EV/EBITDA ratio of 10 times). Applying the same valuation to the adjusted operating profits reported at ITV’s studios last year leaves that part of the business with an enterprise value of £2.59bn - not too far from current enterprise value of the entire business. Analysts have suggested that those who buy ITV’s shares at their current price are getting a studios business with the media and entertainment arm thrown in for nothing.

It’s an interesting argument, but it is one that I am wary of. ITV’s studios are not growing at the pace they need to, while the media and entertainment business looks in danger of having its revenue and profits further eroded. It’s a competitive environment and ITV may have left its investment too late.

Lookout for: ITV’s plans with its surplus cash from the Britbox divestment and any other capital-raising plans

Do great companies always make great investments?

Spirax-Sarco Engineering (LON:SPX) andGreggs (LON:GRG) both report final results this week. They’re both well held, popular shares among UK Investors, but they are a lesson in the fact that great companies don’t always deliver consistently for their shareholders.

Spirax-Sarco is an incredibly high quality operator. Its operating margins have barely dipped below 20% in the last five years and its return on capital employed has always been similarly high. Its management also have a good attitude to reinvesting the cash profits from the business - operating cash conversion always tends to exceed 100%.

But with this high quality has come an extremely high valuation which means any weakness has been harshly punished. And in the last couple of years Spirax has become worryingly reliant on the growth from just one of its divisions, sending the share price down sharply.

Greggs is another example of a company which, operationally, barely puts a foot wrong, but has failed to capture the same level of shareholder excitement as it once did. Another high quality company, with strong margins and excellent cash conversion, Greggs has reinvested in expanding the store footprint and innovating with opening hours and meals. But convenience food is a competitive market and as growth has stalled, a price to earnings ratio in excess of 20 times has become harder to justify.

Lookout for: A return to reliable growth, enough to justify lofty price to earnings ratios

Medical devices: Does the UK’s offering stack up?

ConvaTec (LON:CTEC) final results are due on Wednesday, just over a week after its peer in the UK medical devices market (Smith & Nephew (LON:SN.) ) announced its own numbers.

The medical device market is an interesting one. Barriers to entry are phenomenally high because companies tend to supply their products to massive customers (the NHS, for example) who are unlikely to switch. Innovation is important, but companies which reinvest their profits sensibly should enjoy a virtuous circle of high, reliable demand and rising prices.

But winning new business is challenging and growth is hard to come by. The market is dominated by the US giants like Abbott Laboratories (NYQ:ABT) and Stryker (NYQ:SYK) and Danish groupColoplast A/S (CPH:COLO B) . Competing with these giants is tough ask for the British contingents, ConvaTec and Smith & Nephew.

The former announced its final results last week, which were well received, despite a fair number of complicated adjustments. Smith & Nephew plans to focus on its orthopaedics division where it is one of the biggest players in the world and can remain competitive.

ConvaTec has struggled to grow since it arrived on the stock market after a much-hyped IPO in 2016. It still sits on a hefty volume of debt which has been problematic in a time of rising interest rates.

This is an area of the market where investors are better off looking across the pond. In 2023, Stryker reported $20.5bn of revenue, up 11% on the previous year. And sales are expected to continue growing at double digit pace for the next couple of years.