Market Report: Bargain hunters engineer strong gains for IMI

IMI surged as bargain hunters, eyeing the resilience of the engineering group's earnings, moved in to profit from recent losses last night.

The stock rallied by more than 8 per cent or 46.5p to 624.5p, recouping part of the slide since the end of April, with UBS telling investors to make the most of the pullback. The broker said that not only does IMI trade at a significant discount to its peers, but that in the event of a double dip in the economy, it faces a relatively limited cut to earnings. Testing its forecasts against the possibility of another slide into recession, UBS expects its forward estimates for IMI to come down only in line with the sector average, while the valuation is well below the norm.

"In our scenario, we assume that there is a pullback in revenues in the second half of 2010, followed by no growth in 2011. For a standard industrial company, this means revenues run at [the levels seen in the fourth quarter of 2009] and do not improve," the broker said, raising IMI to "buy".

"Combined with operational leverage, the sector would see 20 per cent cuts to earnings, although some companies fair worse."

Overall, the FTSE 100 mounted a relief rally, adding 97.4 points to close at 5,038.08. The FTSE 250 was also buoyant, gaining 203.32 points to 9,392.67 as bargain hunters sought to make the most of Tuesday's losses. The miners, most of whom fell as commodity markets softened amid worries about Europe's debt woes, were among the biggest beneficiaries of the turnaround, with Kazakhmys rising to 1,149p, up 77p, and Xstrata swelling by 52.8p to 927.3p.

The sector received a boost from ING, which said the sell-off had been overdone. "Investors have taken profits in riskier, cyclical investments, particularly those that have performed well over the past year such as commodities and mining shares. The mining sector has also been hit by prospect of a mining 'super tax' in Australia," the broker said, naming Rio Tinto, which gained 208.5p to 3,064.5p, as its top pick in the sector.

Banks also pared losses. Rising interbank interest rates had sparked a wave of selling on Tuesday, but that changed as the market firmed up. Lloyds, which was the hardest hit in the session before, managed to recover by 3.39p to 53.91p, while Barclays gained 13.2p to 297p. Royal Bank of Scotland was 2.4p stronger at 45.1p, with the relief rally offsetting the impact of EU proposals to impose a new levy on banks.

Credit Suisse did its bit to support sentiment, raising both Lloyds and RBS to "outperform" on valuation grounds, and pointing out that, contrary to fears of rerun of the credit crisis, sector balance sheets are much stronger than two years ago. "In 2008, balance sheet structures were weak, opaque and poorly marked," the broker said. "Today, the equity tier 1 ratio [or the capital buffer] is 10 per cent, we estimate that 12 per cent of loans have been written down since 2007 and liquid assets cover 90 per cent of three-month funding [against 20 per cent back in 2008]."

Elsewhere, publishing giant Reed Elsevier rose by 5.9p to 466.5p thanks to a push from the Royal Bank of Scotland. The broker said that though "out of vogue" at the moment, the stock was well placed to rise as changes such as the splitting of the LexisNexis business come to pass. Management's downbeat tone should also improve, although RBS warned that the interim results "will likely be poor, with margins depressed by investment and earnings diluted by last July's equity issue". "The tactical investment would be to buy the shares after the poor interims but ahead of the full year results when the outlook statement should be more positive," the broker said, repeating its "buy" view with a revised 605p target price, compared to 560p previously.

Further afield, Afren, the oil and gas exploration and production group, swung to 89.8p, up 10.65p, after the analysts at Renaissance Capital said they preferred the stock to Africa-focused peer Tullow Oil, which was 46p up at 1,054p. "While we acknowledge the impressive operational success Tullow Oil has had in the past, in the next 12 months, on a relative basis, we believe Afren's shares will outperform," Renaissance said, setting "buy" and "hold" ratings on Afren and Tullow respectively.

The broker said its estimates suggested that Afren was better placed to deliver production growth in the near term, adding: "We estimate Afren is set to deliver 7 per cent production growth in 2010 and 111 per cent production growth in 2011. This is better than Tullow's 4 per cent decline in 2010 and 57 per cent growth in 2011."

On the downside, the newspaper publisher Trinity Mirror was among the laggards, falling by 3.85p to 97.35p after Panmure Gordon, highlighting the potential for volatility, scaled back its target price to 105p.

"At current levels, Trinity's EV [enterprise value] – excluding pension – is 60 per cent debt," the broker said, sticking to its "hold" stance.

"This is actually satisfactory relative to some sector peers. However, geared [business to consumer] names are likely to remain volatile in current market conditions."