ICAP facing headwinds

Trading conditions remain extremely difficult for interdealer broker ICAP (IAP). Its trading update at the end of last month revealed that the group's revenue for the year to end-March is expected to be 13 per cent down on the previous year. Consequently, ICAP reckons pre-tax profit will be around £280m, although cost savings for the year are expected to reach £60m. Conditions in the first nine months were particularly poor, with fragile market conditions and uncertainty over new regulatory requirements hitting turnover. And while there was a better start to the fourth quarter, chief executive Michael Spencer admitted that there are no signs of a sustained upturn.

True, bid speculation pushed the shares up over 6 per cent in one day at the start of the month - after Nasdaq OMX bought eSpeed, the main rival to ICAP's Brokertech electronic Treasury trading platform. But analysts point out that most exchanges are currently tackling major integration issues and are unlikely to want to pay the sort of premium that would be needed to successfully acquire ICAP. Significantly, the group is being probed by regulators, too. In the UK, a subsidiary is under investigation by the Financial Services Authority regarding the Libor rate-rigging scandal. While, in the US, the Commodity Futures Trading Commission is probing ICAP over the possible manipulation of interest rate swap prices.

Numis Securities says...

Reduce. With significant regulatory risks and a poor operating environment, it is too early to buy shares in ICAP. There's also a risk that the regulator could decide that there is an operational risk within ICAP which, in short, could require the group to make a significant addition to capital reserves. Furthermore, the main stimulus to significant growth is an increase in US interest rates, but such a move looks to be a long way off. Meanwhile, ICAP's customer banks will continue to reduce their trading activity. Accordingly, we have downgraded our pre-tax profit estimates by 6 per cent to £281m for the year to end-March 2013, giving EPS of 31.5p, and from £321m to £302m, giving EPS of 33.8p, for 2014.

Shore Capital says…

Buy. The near-term outlook for ICAP is uncertain and management stressed that it's not seeing a sustained upturn, with market activity remaining fragile. Accordingly, we have downgraded our 2013 and 2014 adjusted EPS forecasts by 3 per cent and 4 per cent to 30.9p and 33.7p, respectively. However, we believe that the company is well positioned to grow over the medium to long term because of its exposure to electronic broking and post-trade business, both of which could benefit from regulatory change. But the key valuation attraction is the prospective dividend yield of 7.3 per cent, which is covered 1.4 times and, in our view, looks pretty safe given the strong cash generation of around 100 per cent profit conversion. We anticipate a Libor fine of up to £100m, but this could be paid from reserves without cutting the dividend.