FTSE Rebalance: Oil Out, Pharma In

Tullow Oil is set to be replaced by Hikma Pharmaceuticals, reducing the FTSE 100's energy portfolio and boosting its pharma weighting

Holly Cook 2 March, 2015 | 3:57PM
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The FTSE 100 index could get a fraction more stable later in the month, when Tullow Oil – one of five oil producers on the index – is expected to be demoted to FTSE 250 status, and replaced by a members of the typically more stable pharmaceuticals sector. 

The slumping oil price slump over the second half of 2014 dragged with it oil exploration and production firm Tullow Oil (TLW), which has seen its shares halve in value over the past six months. A preliminary survey of the FTSE 100 and 250 constituents at the end of last week confirmed that Tullow is first in line to be relegated to the mid-cap index when the FTSE Group carries out its quarterly index rebalancing. 

Tullow closed on Friday a little over 387p per share, but Morningstar analyst Stephen Simko believes the stock should be worth 650p apiece, citing his expectation that Tullow’s portfolio of growth projects should begin to generate significant free cash flow when completed at the end of the decade. The cash burn in the interim is enough to materially stress the balance sheet, Simko says, but he believes management’s intelligent financing decisions will allow the firm to withstand a lot of financial pressure. With the shares currently undervalued versus Simko’s fair value estimate, Tullow boasts a 4-star rating from Morningstar. 

Replacing Tullow on March 32, pending confirmation from the FTSE EMEA Committee on March 4, will be Hikma Pharmaceuticals (HIK). Hikma is in pole position to be promoted to the FTSE 100 following a 25% share price rise so far this year. Morningstar’s Michael Waterhouse values the shares at 1,600p – substantially less than the Friday closing price of 2,473p and hence the cause of the stock’s 1-star rating from Morningstar. 

Profitability margins have been expanding, particularly in Hikma's injectables unit and developed markets generic segments, but Waterhouse continues to the eventual competition on some of Hikma's key products will apply pressure to this margin trend. Despite its many positives, Hikma “lacks the capabilities of industry leaders, namely large-scale manufacturing operations, an adept legal department and vertically integrated operations,” Waterhouse says. 

Among mid-caps, AA (AA.), Virgin Money Holdings (VM.) and Imagination Technologies Group (IMG) are currently in line to join the FTSE 250, while Afren (AFR), Game Digital (GMD) and Oxford Instruments (OXIG) are preparing themselves for demotion to the FTSE Small Cap Index.

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Holly Cook

Holly Cook  is Manager, Morningstar EMEA Websites