TheChek News Flow

Deadline for Recharge Industries to finalise purchase of site runs into impasse with EY

Recharge Industries’ attempt to buy the Britishvolt site is at risk of collapse due to a dispute between the Australian company and administrator EY over a power supply contract signed by the failed battery start-up, according to people familiar with the matter.

The Geelong-based business bought Britishvolt’s intellectual property — 23 staff and its prototype battery technology — for £8.6mn last month and under exclusive rights had until Friday to pay for the coveted land in Blyth, north-east England.

Recharge has yet to pay the £9.7mn for the land despite the deadline passing, and the deal is in jeopardy after the two sides hit an impasse over payments related to transferring a grid connection contract with National Grid, according to two people familiar with negotiations.

The setback adds to the scrutiny that EY is coming under for its dual role as strategic adviser to the firm during its life — resulting in it becoming the battery company’s fifth-largest creditor — and administrator upon its collapse.

EY said in a statement that the administrators “are not requesting that Recharge make any additional payments beyond those contractually agreed as part of the sale. The company will only retain funds, including any received from third parties, to which it is entitled to.”

Recharge believes it is entitled to receive a refund made by National Grid to the EY-controlled Britishvolt bank account since it must pay the equivalent amount to the UK electricity system operator, according to one person.

The collapse of Britishvolt and troubles for its successor have dealt a blow to the UK’s ambitions to foster an electric car industry and attract the battery plants that would form the cornerstone of it.

Battery manufacturing consumes a lot of electricity, making access to plentiful and cheap power vital for any factory. The Blyth site is widely considered one of the best in the UK and is the ultimate prize for Recharge Industries because it is located next to an interconnector that would supply clean and affordable power.

The opposition Labour party has pledged to provide £2bn to support the construction of eight battery gigafactories in the UK to sustain the country’s automotive industry if it were to form a government. However, the window for the UK to secure battery plant investments is rapidly narrowing as automakers make momentous decisions on where to locate their supply chain.

Founded in 2019, Britishvolt entered administration in January after limping between financing rounds without firm customer orders and running out of cash to build its envisaged £3.8bn battery plant.

Recharge Industries, which is run by former PwC partner David Collard, has threatened to walk away from buying the site if there is uncertainty over the status of its access to a grid connection, the people said.

Recharge Industries declined to comment.

Move expected to attract private equity interest as Germany seeks to boosts its military capacity

German industrial group ThyssenKrupp has revived plans to sell its submarine and maritime systems unit, a move likely to face scrutiny from politicians and government officials as Berlin seeks to boost its defence manufacturing.

The decision was announced by employee representatives on Friday in an email to workers seen by the Financial Times. Employee representatives make up half of Thyssenkrupp’s supervisory board.

A bidding contest is expected to start after Easter, according to three people close to potential buyers. Private equity firms are among the parties interested, they said.

The division, which includes the group’s shipyards in Kiel in northern Germany, acquired a shipyard in Wismar last year in anticipation of more submarine orders from the German government. In 2021 the group won a €5.5bn contract to deliver four of the vessels to Norway and two to Germany.

It generated €1.8bn in sales last year and €32mn in adjusted earnings before interest and tax in 2022.

Russia’s invasion of Ukraine has led to mounting interest from buyout groups into the defence sector, as governments across Europe increase military spending.

That has prompted what German chancellor Olaf Scholz has called a Zeitenwende, an epochal shift, spurring the country to massively increase its military spending, revamp its army and bolster its defence industry, after decades of reluctance in the wake of the country’s second world war legacy.

But one person close to ThyssenKrupp said the company did not expect the government to intervene. Board discussions on Friday suggested that Berlin “supports the formation of a strong national shipbuilding company”, according to the employee memo.

A committee would be set up in the “near future” to “take the interest of the employees into account”, according to the memo to workers.

ThyssenKrupp declined to comment for this story.

ThyssenKrupp, once a symbol of Germany’s industrial might, has for years been plagued by losses as it grapples with slowing demand from the country’s automotive industry for its steel.

The 200-year-old company is in the final phase of a restructuring to pay down debt. Over the past years the Essen-based group has sold its car parts and infrastructure businesses, an Italian stainless steel plant and its elevator operations, which it sold for €17bn in 2020 to private equity.

The company’s share price dropped by more than 8 per cent last month when the company said its plans to offload its marine systems and steel units were delayed.

Employee representatives noted on Friday that there were no “concrete plans” regarding Thyssenkrupp’s steel unit — which was the original activity of the group — nor regarding its stake in the Hüttenwerke Krupp Mannesmann plant.

They criticised management lead by chief executive Martina Merz for the delays. “There has been a lack of an overall concept from the board for months,” they wrote. “Nothing has changed since last autumn and time has been wasted again unnecessarily.”

The road to a U.S. ban on TikTok, the popular app owned by Chinese company ByteDance, is long and twisted, even as support builds for bipartisan legislation that would give the White House authority to ban not just TikTok but other Chinese information and communications technology companies. Expect more volatility for Chinese and U.S. companies along the way.

But the direction of travel is clear: The U.S. and China are in a slow-motion decoupling in critical areas like technology. TikTok, the short-video app used by 150 million Americans, is the highest-profile company targeted by the U.S., as policy makers increasingly view the relationship with China through the lens of national security. But it’s not the first or most important Chinese company to get caught in the crosshairs, nor will it probably be the last.

Companies have been bracing for retaliation from China for measures the U.S. has taken. But nothing significant has happened, even after the U.S. in 2019 blacklisted China’s Huawei Technologies, the world’s largest maker of telecom equipment, curtailing its access to advanced chips. China also hasn’t retaliated after the Biden administration last fall restricted China’s access to advanced chips technology, hampering Beijing’s efforts to build up its domestic chip industry.

“Banning TikTok, or forcing a sale, would not inflict significant pain on China and is certainly far less of an issue than other recent decisions by Washington,” says Andy Rothman, investment strategist at Matthews Asia. While a decision to ban or restrict TikTok would further strain the relationship, Rothman doesn’t expect Beijing to take retaliatory actions against U.S. companies.

Part of the reason: Options are limited. “Beijing has been wanting to do something to push back, but it didn’t have leverage in the tech ecosystem to counter U.S. efforts,” says Xiaomeng Lu, director of geotechnology at Eurasia Group, who thinks that Beijing’s retaliation will focus on prohibiting the divestiture of TikTok or the transfer of its algorithm in any sale.

That would force the U.S. to pursue a ban, possibly in an election year when both sides are courting younger voters who view TikTok as a daily necessity rather than a national security risk.

Though China has limited immediate options to retaliate much further, Lu says it is positioning for the long run by reshuffling government agencies and retooling its chip strategy to bolster its defenses, and in ways that could potentially disadvantage U.S. companies.

Others see China making subtle decisions like sitting on mergers before Chinese regulators or rewarding European or Asian rivals of U.S. companies. For example, Gavekal’s head of research, Arthur Kroeber, says that U.S. carriers didn’t get a single flight slot at Beijing’s second-largest airport when it recently opened.

But a consumer-oriented boycott or move against companies with significant operations in China, such as Apple (ticker: AAPL), is unlikely. “Retaliation against Apple or any firm like that would be counterproductive. They want to preserve the ecosystem and capability and relationships that having Apple operating in China and Foxconn assembling phones create,” says Thomas Gatley, senior analyst at Gavekal, noting that’s especially true as companies like Apple look to diversify their supply chains.

The takeaway for investors: While most of the companies ending up on U.S. blacklists aren’t publicly owned, a handful of big Chinese technology and internet companies, including Alibaba Group Holding BABA –1.16% (BABA) and Baidu BIDU –1.89% (BIDU), have cloud businesses or data that could eventually put them in the crossfire.

For those drawn lately by China’s economic recovery prospects, focusing on companies catering to Chinese consumers may be a less volatile way to participate, through exchange-traded funds like Global X MSCI China Consumer DiscretionaryCHIQ –0.88% (CHIQ) or active funds from veteran emerging markets managers who tend to favor companies focused on domestic consumers, like Matthews China fund (MCHFX) or William Blair Emerging Markets Growth (WBEIX).

For those focused on the U.S., the investment impact will be felt over the course of some years, as companies reassess new investments in China following three harsh years of Covid restrictions that pummeled the economy. China’s crackdowns on the property and technology sectors, and President Xi Jinping’s interventionist policy approach, also are considerations.

Another variable: The U.S. has increased scrutiny of investments in China and restricted access to core technologies, while China is beefing up efforts to rely less on the U.S. and others.

“It is becoming increasingly treacherous for multinational corporations to navigate through barriers to private enterprise that are being constructed by the U.S. and Chinese governments—and some are finding themselves forced to choose which of the world’s two largest economies is more important to them,” says Kurt Tong, a managing partner at consultancy the Asia Group and former U.S. consul general in Hong Kong.

These shifts will be like ice melting—a very slow but significant reshaping of relationship and corporate strategy that will create spillovers in different parts of the global economy and markets—and that will force a rethink by investors and companies.

“This is a multidecade regime change, one in which national security has replaced economic interests,” says Mohamed El-Erian, chair of Gramercy Funds Management and former deputy director of the International Monetary Fund. Increased nationalism in China could push U.S. companies to follow in the footsteps of Yum! Brands (YUM), which spun off its China operations years ago into Yum China Holdings YUMC +0.64% (YUMC). “Today, Yum China is viewed as a Chinese company, but Yum! Brands receives dividends,” El-Erian says.

The bigger question may be the outlook for Chinese companies operating in the U.S., especially if the Restrict Act passes in its current form. Such legislation could create an existential risk for Chinese technology companies in the U.S.—and, if nothing else, make it difficult for these companies to expand in critical sectors that fall under a broad national-security umbrella.

Even if the U.S. and China maintain a “managed decline” in their relationship, Chinese telecom, aerospace, defense, and technology companies—especially semiconductors and quantum-computing companies—could be targets of additional restrictions and sanctions, says Clayton Allen, a director at Eurasia Group focusing on politics and policy.

The battle could also expand to new fronts, including inputs for electric vehicles, an area where China has more leverage, given its dominance in parts of the clean-energy ecosystem.

“The two complementary economies attract each other like magnets, but a thicket of economic and national-security concerns—and a backdrop of deep distrust—are pulling deals apart,” says Asia Group’s Tong.

Utility stocks have disappointed this year, losing 5%, on average, compared with a gain of 5% for the S&P 500SPX +1.44% index. Although that’s frustrating for shareholders, there may be a silver lining: more attractive valuations and higher yields for investors looking for defensive plays if the economy deteriorates.

These stocks aren’t dirt cheap, even with the recent underperformance. The S&P 500 Utilities IndexSP500.55 +0.76% fetches about 18 times this year’s profit estimates, below its five-year average of 19.2 times, but in line with the market average. However, utilities yield 3.3%, on average, nearly double the S&P 500’s 1.7%.

Investors can pick up more income in cash proxies like money-market funds, six-month T-bills near 5%, or two-year U.S. Treasuries at 4.1%. But utilities should benefit from a smoother interest-rate climate once the Federal Reserve stops raising rates, possibly in the next few months. Utilities may also offer more capital appreciation than bonds if the economy weakens and investors shift to defensive stocks.

“If a rotation is going to occur, it’s likely because something gets worse, in which case you want to own defensive sectors,” says Liz Young, head of investment strategy at digital bank SoFi.

Moreover, utilities offer dividend growth, while bonds pay fixed income, based on their coupon rates. Eventually, bond investors will have to reinvest into lower-yielding cash vehicles, “versus a utility dividend that is growing over time,” says Bobby Edemeka, a PGIM Jennison UtilityPRUAX +0.85% fund (PRUAX) portfolio manager.

Jay Hatfield, who runs the actively managed InfraCap Equity IncomeICAP +0.97% exchange-traded fund (ICAP), says he recently increased his utility allocation by a few percentage points, to 15%. “We don’t know what the next trend is, but it’s reasonable to be cautious until the banking crisis is resolved and/or the Fed goes on hold” with rate hikes, he says.

The fund’s holdings include Duke Energy (DUK), which yields 4.2%; Southern Co. (SO), at 3.9%; and Dominion Energy (D), at 4.8%.

Edemeka says that electric utilities have strong tailwinds, such as a growing emphasis on clean energy. They are also investing capital to upgrade their portions of the grid for transmitting and distributing power for things like electric vehicles, allowing them to charge higher rates to recoup capital expenditures. “They are well positioned to sustain consistent earnings and dividend growth,” he says, adding that he expects annual dividend increases of 5% across the U.S. electric utilities spectrum.

One of the fund’s holdings is CenterPoint Energy (CNP), a Houston-based utility that is investing heavily to upgrade its Texas grid, partly because of some bad storms. Analysts expect CenterPoint to earn $1.49 a share this year, up from $1.38 in 2022, and $1.62 in 2024. The stock yields 2.6%. Last year, the company’s dividend payout ratio—the percentage of profits it dispenses to shareholders—was about 50%, below the peer average of 65%, according to Edemeka. That should give it enough room to keep boosting its dividend at a 7%-to-8% annual clip.

Another holding is Ameren (AEE), based in St. Louis and yielding 2.9%. The company is investing in its transmission and distribution grid, and it’s shifting power from some coal plants to renewable sources. All of that should support 6%-to-8% earnings growth, says Edemeka. The company’s payout ratio last year was a little below 60%, leaving upside for the dividend.

SoFi’s Young likes the setup for the sector overall. “Utilities feel like a better place to build that defensive exposure if you don’t have it,” she says.

Banks are likely to feel pressure from all sides for the foreseeable future.

It isn’t just depressed valuations and the specter of more regulation in response to the collapse of Silicon Valley Bank and Signature Bank. Banks are also going to be struggling with ramifications of an increasingly challenging deal-making climate.

With the Federal Reserve expected to slow—or even pause—interest-rate hikes, Wall Street has been hoping that merger-and-acquisition deals would increase as funding costs stabilize, giving a much-needed boost to banks’ advisory fee revenue. But the recent banking turmoil has raised concerns that reduced lending and greater risk aversion might spill over to nonbank industries, again putting deal making on ice despite recent signs of growth.

“How long it will take for green shoots to re-emerge remains to be seen, but with financing costs rising/availability tightening, there was clearly less confidence in activity inflecting in the second half of 2023,” writes Wolfe Research managing director Steven Chubak in a research report.

And banking may face other pressures as it becomes a target for deal making. Regional and larger savings banks have grown increasingly vulnerable to activism after their financial position weakened due to the rising cost of funding, notes Jason Frankl, a senior managing director at FTI Consulting, in a report.

While consolidation for the industry would be welcome to shareholders, it could cause unwanted noise in the near term.

Rolls-Royce is synonymous with classic British luxury cars. But the company doesn’t actually make cars anymore—that unit has been a subsidiary of Germany’s BMW since 2003.

Rolls-Royce still exists as its own company, though. It is mainly an aerospace firm, making and maintaining high-powered engines. It’s more like General Electric than Ford .

Shares of Rolls-Royce Holdings (ticker: RR.UK) have jumped this year under new Chief Executive Officer Tufan Erginbilgic on hopes he will turn things around after years of underperformance.

Rolls-Royce’s underlying profit rose more than 50% in 2022. The company gets the bulk of its income from servicing aircraft engines, and it says that engine flight hours, a key metric, will continue to increase this year. It expects flight hours to reach as much as 90% of the prepandemic levels of 2019 this year. They were at just 65% of that in 2022.

“Historically, Rolls-Royce has traded at a low valuation to peers,” say analysts led by George Zhao at Bernstein. “The strong 2022 finish and 2023 [guidance] could lead to optimism for investors that the company is on the path to improved performance and improved confidence.”

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London-based Rolls-Royce employs 41,875 staff and has a market value of 12.3 billion pounds sterling ($15.1 billion). It develops, manufactures, and services power systems, or engines, for vehicles on land, air, and sea.

Rolls-Royce fetches 27.4 times this year’s expected earnings and is valued at a 60% premium to peers. Shares are up 53% this year, to £1.43. The average target price among 12 analysts surveyed by FactSet is £1.52.

Christophe Menard, an analyst at Deutsche Bank, says shares could rise to £1.60. That’s on the back of a prediction that operating profit will climb by around 19%—and that’s without an expected boost from Erginbilgic’s latest turnaround drive.

Erginbilgic, a dual Turkish-British national, took the helm in January. Rolls-Royce had a difficult pandemic as travel restrictions kept most airplanes grounded. Predecessor Warren East launched a restructuring program in the wake of the Covid-19 downturn, eliminating 9,000 jobs to save on costs.

When Erginbilgic started the job, he said the company was in danger of becoming a “burning platform” and that it was a last chance to win investors back. He pledged to focus on efficiency and optimization, and demanded that the business worry more about profit and loss and less about increasing market share.

Erginbilgic spent more than 20 years at oil and gas giant BP, leading its refining and market division and overseeing the company’s investments in electric-vehicle charging.

He left BP in 2020 after being passed over for the top job. He told journalists he was attracted to Rolls-Royce because of its global brand, and because it was an opportunity to help transition the company to a low-carbon future.

The more immediate task for the new CEO is returning Rolls-Royce shares to their former glory. They traded as high as £3.60 in 2014, and were above £3 in May 2019, not long before the Covid-19 pandemic struck.

Bernstein’s Zhao still sees a risk that shares could falter if the company can’t follow through on its new plans. His price target is £1.08, 28% lower than where shares are currently trading.

“We will need clarity on new targets and strategies,” Zhao says, adding that the company still needs to execute and deliver on the targets.

“That will take time, with downside risks of false starts,” he says.

Regional banks have received merciless scrutiny since the collapse of Silicon Valley Bank on March 10. Uninsured deposits and cash levels have been weighed—and where they’re found wanting, bank stocks have been cut in half.

The next worry for regional banks could be commercial real estate. Postpandemic changes in how we work and shop are leaving vacancies across the country. If a recession arrives, experts warn, large numbers of property owners could default on their loans.

Which lenders have the most at stake? Banking regulators have set guidelines for concentration in commercial real estate loans, so Barron’s asked S&P Global Markets Intelligence to scour federal filings for banks that exceed those levels. We then focused on the 15 largest banks in that group.

These lenders are mostly midsize banks in the bottom half of the nation’s top 100 in assets. Commercial real estate is their concentration, the banks tell Barron’s, because they’re good at such loans. Judging by their below-industry levels of bad loans, that seemed to be the case at year-end 2022. At 11 of the 15 banks, nonperforming loans amounted to less than half the regional bank median of 0.84% of total loans.

Most say their loans are well covered by the values of the properties—suburban office parks, retail locations, apartment buildings, and more. But if the foundations crack under commercial property in the coming year, investors will want to keep an eye on these and other local banks. In all, regional and community banks account for an estimated 80% of commercial real estate lending.

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The Panic is Ending

Some names on our list are familiar from recent headlines. The second-largest bank on the list is Pacific Western Bank. The shares of its Beverly Hills, Calif.–based holding company, PacWest Bancorp (ticker: PACW), skidded wildly after its venture-backed depositors pulled cash in the wake of Silicon Valley Bank’s collapse. PacWest lined up funding and says it has more than enough cash to cover uninsured deposits. Its loans are diversified and in good shape, it says.

PacWest’s loans include many for real estate. At the end of 2022, commercial real estate loans amounted to more than 375% of Pacific Western’s capital, its cushion for loan losses. The riskiest kind of real estate loans—for land and construction—came to almost 140% of the bank’s capital.

Federal guidelines define two tests that may prompt regulators to further analyze “the level, nature, and management” of a bank’s commercial real estate concentration risk. The first test is whether loans for non-owner-occupied commercial real estate exceed 300% of a bank’s capital and have grown more than 50% in the past 36 months. The second test is whether loans for construction and land development exceed 100% of capital.

Like all the banks we list here, PacWest exceeded the level of one or both of these “300/100” tests.

Commercial real estate loans are often a leading indicator in a downturn, when speculative land loans are some of the first assets to run into trouble, says banking consultant Kathryn Dick, who was deputy comptroller at the Office of the Comptroller of the Currency in 2006 when the loan concentration guidelines were developed.

“The crux of that guidance is to have a trigger point for a conversation with the regulators,” says Dick. “It was issued as guidance, not a hard-wired limit, because at many community banks, this is their bread and butter.”

PacWest didn’t respond to questions from Barron’s. But when PacWest reported 2022 earnings in January, Chief Executive Paul Taylor expected its “relationship” real estate lending would continue. “As you look at our balance sheet,” he told conference-call listeners, “one thing we do very well, and a lot of, is real estate.” At year end, the bank’s nonperforming loans—including loans past due by 90 days or more—were just 0.38% of total loans.

The largest lender with commercial real estate loans above the guidelines in December was Valley National Bancorp (VLY), a New York and New Jersey–focused lender whose commercial real-estate loan level was 440% of capital, after rising more than 70% in the prior three years.

Senior Vice President Marc Piro says that two acquisitions contributed to Valley’s growth. The bank’s commercial real estate loans are “highly diversified by region, property type, and loan size,” Piro writes. “We hold a highly granular portfolio with no significant concentrations in any specific area and continue to maintain exceptional credit quality.”

The third-largest bank with high concentration levels is Bank OZK (OZK), a Little Rock, Ark.–based lender whose commercial real estate loans topped 345% of capital in December, with construction and development loans topping 180% of capital. Saying it is in its quiet period, OZK wouldn’t comment on its loans. In its 10-K filed with the Securities and Exchange Commission in February, the bank acknowledged the lending concentration but said it has established appropriate underwriting and monitoring procedures for the loans. At year end, its common equity was among the highest of the banks on our list, at 14% of assets.

No. 4 on our list of concentrated lenders is Pacific Premier Bancorp PPBI +0.88% (PPBI), an Irvine, Calif.–based bank whose commercial real estate loans more than doubled over the three years ended December 2022, to a level of 329% of its capital. Two-thirds of those loans were for multifamily residential buildings, says a spokesman, and they have performed well.

“These [commercial real estate] loan concentrations have been well-managed through various economic and interest rate cycles,” he writes. “We have longstanding, disciplined credit underwriting standards.”

The shares of Washington Federal (WAFD) have held up better than most on the list. That’s because the Seattle-based bank’s loans are secured by commercial properties worth twice the loan amounts, says marketing chief Brad Goode. “Our nonperforming assets are one of the lowest among regional banks,” he says.

Real estate lending can be a profitable source of growth for banks that know their territory. The greater Washington, D.C., base of Sandy Spring Bancorp (SASR) has seen powerful growth in housing, offices, and retail for over a decade. The bank’s commercial real estate loans exceeded 360% of capital at December’s end, after doubling over the prior three years. A 2020 acquisition contributed to that growth. In an earnings call in January, CEO Dan Schrider said that retail was the largest piece of its loan portfolio, at about 29%, with another 15% in suburban offices.

“We just keep our loan-to-value ratios very low.”

— Greg Garrabrants, Axos Financial

Almost all the loans in the commercial real estate portfolio of First Foundation (FFWM), a Dallas–based lender, are on multifamily residential properties, says CEO Scott Kavanaugh, with the loans averaging a conservative 55% of the properties’ values when made. The bank’s percentage of nonperforming loans is the lowest on the list. “Multifamily is the best asset class in commercial real estate, in terms of default rates,” he says. “We’ve never taken a charge-off in our multifamily loans.”

From its base on New Jersey’s shore, OceanFirst Financial (OCFC) makes most of its commercial loans in the region from New York City to Philadelphia. Spokeswoman Jill Apito Hewitt says the bank has a diverse loan portfolio, with few urban offices. Only 0.11% of its commercial real estate loans were nonperforming last year.

Barron’s asked every bank on this list about their lending. All but seven responded.

While the 300/100 tests can lead to conversations about loan concentration, they may also highlight a bank’s expertise. San Diego–based Axos Financial (AX) had commercial real estate loans that exceeded 420% of capital at December’s end, with construction and development loans at 110% of its capital.

But Axos shares have dipped the least of all our listed concentrated lenders. The bank has low levels of uninsured deposits and one of the industry’s lowest levels of unrealized losses in its bond portfolio—the two most prominent pain points for regional banks in recent weeks.

Axos also has a distinctive way of real estate lending, in which it takes loan interests that are senior to nonbank lenders such as the Michael Dell family office MSD Partners, with whom the bank helped finance last year’s sale of Donald Trump’s Washington, D.C., hotel. Such arrangements keep Axos’ loans-to-value levels below 50%, so the properties would have to fall by half in value to endanger the collateral.

“We just keep our loan-to-value ratios very low,” says CEO Greg Garrabrants. “We are in a senior position and well secured in all of our commercial real estate and lender finance deals, including significant subordination from our fund partners.”

So, the concentrated levels of commercial real estate lending at a bank can represent risk...or a bank’s local expertise.

“Community and regional banks across the country fill a very important role,” says Sandy Spring Bank’s Schrider. “The last thing we want to do is see that role in the nation’s economy disrupted.”