Resolution of Evergrande crisis on horizon as Morrison’s sale could spur other UK targets

The big news as we start the week is that Evergrande, the highly indebted Chinese real estate developer that has $300bn in outstanding liabilities, is expected to be rescued by its rival, Hopson Development. Shares in Evergrande, Evergrande Property Services group and Hopson Development were suspended from trading on the Hang Seng on Monday pending an announcement. The announcement is expected to be that Hopson Development will agree to take a 51% stake in Evergrande, which should net the troubled developer some $5bn. This cash could be used to pay back some of its debts, but we will have to see who takes the brunt of this re-structure, with international bond holders expected to suffer the most. 

Markets calmer at the start of a new month 

Evergrande is not China’s “Lehman’s moment” according to some analysts, because the problems were not as widespread throughout the financial system. However, the real estate sector is the equivalent of 30% of Chinese GDP and Evergrande’s debts total 2% of China’s GDP, so its rescue was important to financial markets and general market sentiment. In September, global risk appetite was rocked by news of Evergrande’s problems, thus, we could see a lightening of the market mood later on Monday. European stocks are expected to open higher, after a tumultuous performance last week. As we start the new quarter there are signs that sentiment is picking up, volatility slumped on Friday and US stocks eked out some gains. Thus, it could be Europe’s turn to play catch up at the start of a new week, although at the time of writing opening gains are expected to be limited for Europe’s bourses. 

The future of the FTSE 100 and Morrisons takeover battle  

The FTSE 100 will be in focus this week after the weekend’s auction of supermarket giant Morrisons. The winner was eventually CD&R, who bid 1 penny more per share than Fortress, Morrisons other Private Equity suitor. Private Equity is trying to soften its image, for example, CD&R has spoken about the heritage of Morrisons that it wants to preserve, and it seems to have a deep understanding of the UK grocery space. It also said that it had no plans to sell off Morrison’s store estate, which is the jewel in Morrisons crown. Its headquarters will remain in Bradford, it will honour the £10 minimum wage for all staff and suppliers, and it will offer additional support for the pension fund. Of course, it is easy to agree to these terms when you are buying a well-run, and highly cash generative business like a major supermarket in a major market. However, CD&R’s stance could soften regulators’ views on takeovers and allow more foreign purchases of strategically important UK companies in the coming months. 

Who could be next?

Interestingly, the French government blocked the sale of Carrefour to Canadian firm Alimentation back in June, thus, the ease with which foreign companies can buy big names in the UK could trigger of wave of sales in the coming months. Added to this, since Covid private equity firms are awash with cash and waiting to pounce. Fortress, the unsuccessful bidder for Morrisons, said that it is still interested in buying in the UK, so who could be next? Other listed supermarkets are now in the picture, including Sainsbury’s and even the behemoth, Tesco, since PE companies have got the money to do it. Marks & Spencer could also be in the picture, especially since its online tie-up with Ocado could be attractive. The truth is the UK is PE’s oyster right now. In terms of the impact of PE rumours/ confirmed interest on stock prices, it can be huge. Although Morrisons share price closed at 297p on Friday, higher than CD&R’s successful bid price, its share price has surged 60% since interest from private equity was first made public in June. Thus, expect big gains from whoever gets targeted next. For what it is worth, we think Sainsbury’s could be next. Firstly, it has a decent store estate, it has a strong chain of convenience stores, a solid online offering and it owns homewares brand Argos. We shall have to see what happens next. 

Tesco ditches HGV for trains  

Tesco will announce its interim results on Wednesday, and they are expected to announce a large share buyback, which will hopefully boost its share price, which could be good timing if it is expecting a bid for the business any time soon. Results will be watched closely, as will the CEO’s comments about the supply chain crunch and the risks of empty shelves in the run up to the important Christmas trading period. We will also listen out for the CEO’s plans to deal with the shortage of HGV drivers in the UK, and more about his plans to transport fresh food from Spain to the UK via train. Overall, Tesco’s share price could be due a bounce after falling 2% on Friday, more than its rivals, especially as news of the share buyback have been announced over the weekend. 

Sterling forecast 

Talk of UK M&A goes hand in hand with the FX market. GBP fell to its lowest level in a year last week, but it has managed to recoup the $1.35 handle. We expect the pound to struggle vs the USD this year, as the USD continues to attract safe haven flows in this uncertain global economic environment. However, we think that the EUR will continue to struggle vs. the GBP especially as the interest rate differential is in the pound’s favour and should remain so for some time. Key support for EUR/GBP is £0.8520, and if we continue to see a widening sovereign bond yield differential between the UK and Europe then 0.8450 could be on the horizon. 

A sigh of relief after last week’s market anxiety attack 

 Elsewhere, news of Evergrande’s rescue should boost market sentiment at the start of a new week. Investors will be watching the US labour market report closely on Friday. The market is expecting a stronger jobs gain compared to August, as the Delta variant recedes in the US, however, progress on the jobs front will depend on whether or not jobs can be filled, and if there is a reduction in the number of vacancies. The market expects a 500k increase in payrolls for last month. We will also be watching the September activity numbers that are due out in the UK, US and Europe this week. If the data is better than expected, then we could see market sentiment improve after last week’s collective financial market anxiety attack.