Market Report: Credit rating concerns weigh upon WPP

The world's second-largest communications services group, WPP, eased back by 3.1 per cent, or 14.5p, to 460.7p last night after UBS highlighted potential for near-term weakness in the company's stock, which has been performing strongly of late.

With recent events suggesting that companies might increasingly focus on protecting their credit ratings, the fact that both Standard & Poor's and Moody's switched the outlook on their respective ratings for WPP to negative may start to weigh on the share price. UBS said this would limit performance in the run-up to WPP releasing its interim results, despite the fact it may not have to raise equity to protect its ratings. The broker changed its stance on the stock from "buy" to "neutral", and revised its target price down from 600p to 500p.

WPP should reach a position where the agencies return to a stable ratings outlook next year. To smooth the path if needed, management may consider cutting back on capital expenditure or on the dividend instead of issuing equity. Moreover, WPP makes relatively limited use of commercial paper.

"That said, an 8 per cent placing raising £500m would reduce leverage by 0.4 times and provide more headroom in the event of near-term downgrades – and hence cannot be ruled out," UBS said. It added that while it saw long-term gains in the stock, "given the risk of weak interim results and potential equity raising, there may be better entry points".

In the wider sector, WPP's rival marketing group Aegis closed up 0.05p at 91p after UBS switched its stance to "buy", citing the stock's weakness relative to its peers. "With cost savings likely to provide reassurance that forecasts are underpinned, and no risk of equity raising to protect a credit rating, we believe the under-performance versus WPP and valuation discount to Publicis could close," the broker said, raising its target price for the shares from 85p to 110p.

Overall, investors paused for breath, banking profits and depressing the benchmark FTSE 100 index to 4671.34, a fall of 50.86p points. The FTSE 250 was also weak, declining by 118.35 points to 8302.66. A weak start on Wall Street and news that Britain's trade deficit had widened to £6.5bn in June, against market expectations of about £6.2bn, bore on sentiment.

Friends Provident fell 2.7 per cent, or 2p, as investors banked profits after news that it had agreed to the investment group Resolution's revised takeover bid. In response, Panmure Gordon switched its stance from "hold" to "buy", with its target price a revised from 75p up to 80p. MF Global also weighed in, assessing the read-across to valuations in the wider sector.

"We expect some commentators to claim that Friends Provident is being bought at 0.7 times embedded value and that this should be a benchmark for the valuations in the rest of the sector," said Peter Eliot, an analyst at MF Global. "We disagree and do not see this deal as an acquisition. We see it as a merger in which Friend Provident is gaining management, cash and a pipeline of deals in exchange for some of the upside to its current value."

The rest of the insurance industry, which has been helped by hopes of further consolidation, also fell back amid a round of profit taking, with Aviva easing back by 6 per cent, or 23p, to 358.3p and Prudential falling by 4.1 per cent, or 20p, to close at 466.7p.

Banks remained on the back foot, with Lloyds, which on Monday was hit by speculation about a possible capital-raising, declining by a further 7.1 per cent, or 6.9p, to 90.99p. Morgan Stanley reiterated its "underweight" stance on the stock, and JP Morgan said that "with or without" Lloyds's participation in the Government's asset protection scheme, the bank's shares remained "underweight". It did, however, raise its target price for the stock from 14p to 40p to reflect a more benign economic outlook.

On the FTSE 250, ITV rose by 3.4 per cent, or 1.46p, to 44.96p thanks to Morgan Stanley, which switched its stance on the stock from "equal weight" to "overweight" and revised its target price from 35p to 55p. Analysts cited the broadcaster's first-half results, which showed it was in a "significantly better than expected debt position", thanks to a £113m improvement in its working capital.

There was no such love for Xchanging, which fell by 3.1 per cent, or 7.2p, to 223.7p after Panmure Gordon issued a "sell" note, citing its recent strong share price. "We note other stocks in the business process outsourcing sector, such as Capita and Serco, have been de-rated given the uncertainties around public sector spending, and could start to look more attractive given the quality of their businesses," the broker said. "While Xchanging is more geared towards the private sector, we see no significant positive catalysts in the near term and continue to believe execution risks in certain parts of its business are high."

Among smaller companies, the recruitment group Spring surged by 17.6 per cent, or 9.25p, to 61.75p after it unveiled a recommended cash offer of 62p per share from Adecco, the Swiss recruiter that last year attempted to woo FTSE 250-listed Michael Page International. At the close, Michael Page was 2p weaker at 302.6p.