Managing expectations will be very important for shares in Tesco (LSE: TSCO), Shire (LSE: SHP) and ARM Holdings (LSE: ARM) over the coming months. City analysts forecast these companies to deliver steady earnings growth over the next few years, but are these forecasts overly optimistic?
Recovery on track?
Tesco’s return to profit this year has raised expectations that the recovery in gathering pace. The supermarket’s current focus on reducing costs and improving customer service seems to be doing the trick, and the business is proving to be more resilient than many analysts had initially expected.
Shares in the supermarket are 12% higher than at the start of the year, but they were up as much as 35% in March. By comparison, the FTSE 100 Index is up just 0.4% on the year.
City analysts expect the supermarket, which has been through a transformational year, is firmly on the road to recovery. The consensus forecast of 20 polled investment analysts covering the company expect adjusted earnings per share (EPS) will bounce back by 94% this year, to 6.6p.
Management seems less optimistic though. CEO Dave Lewis warned that trading conditions remain “very difficult” and that the recovery “will not be in a straight line as some people might want”.
Positive investor sentiment
Analysts at JP Morgan Cazenove reiterated its “Overweight” rating on shares in biotech firm Shire, following the announced acquisition of US rival Baxalta. The city broker also lifted its price target to 5,600p from 5,300p, as it expects the acquisition will boost Shire’s medium term earnings outlook and help it to build a more sustainable growth outlook.
JP Morgan Cazenove said it expects the deal would deliver “mid-single digit core EPS accretion by 2020”, and expects a re-rating of valuations for its shares from currently 12 times 2017 expected earnings, to 16 times. With shares trading at 4,290p at the time of writing, its current price target implies a 30% potential upside.
Shareholders of both companies voted on Friday to overwhelmingly support the $32bn merger. 94% of votes cast by Shire shareholders backed the merger, while 99% of Baxalta shareholders voted in favour of the deal. This reflects positive investor sentiment towards the deal and the market’s confidence in the potential synergies of the deal – it is forecast to save around $250m annually in corporate costs alone.
Many of Shire’s previous acquisitions have been major successes and have transformed the once small biotech outfit into one of the fastest growing firms in the market. But, as always, only time will tell if this acquisition will be a major success too.
Investment banks are bullish on shares in Cambridge-based chip designer ARM Holdings. Out of the 28 recommendations, 9 are strong buys, 8 are buys, 8 are holds, 2 are sells and 1 is a strong sell. The median price target for the stock is 1,180p, which implies a potential upside of 20%.
Despite slowing smartphone and tablet demand, the company remains confident that it can deliver full-year revenue growth in line with market expectations. The consensus forecast for revenues for full year 2016 of £1.14bn represents 17% growth on the previous year. Additionally, city analysts believe ARM’s adjusted EPS will grow by 15% this year to 34.6p, as profit margins narrow slightly with rising R&D investment and higher staff costs.
Although analysts’ forecasts indicate ARM’s growth outlook remains relatively robust, its shares have fallen by 5% since the start of the year. Moreover, its forward P/E has dropped from a 3-year historical average of 39.8 to currently just 28.0, which confirms the weakening investor sentiment towards the stock.
Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended ARM Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.