Retail sales are likely to have fallen in October due to the second pandemic wave and related measures, and an even deeper decline can be expected for November. On the contrary, we expect further expansion of industrial production in October, although risks for further growth are accumulating here as well. Consumer price growth should continue to decelerate slowly, although the second pandemic wave has the potential to shake up prices. In the current situation, the CNB will only wait for further developments and comment on the present.

Retail sales are likely to have fallen in October due to the second pandemic wave and related measures, and an even deeper decline can be expected for November. On the contrary, we expect further expansion of industrial production in October, although risks for further growth are accumulating here as well. Consumer price growth should continue to decelerate slowly, although the second pandemic wave has the potential to shake up prices. In the current situation, the CNB will only wait for further developments and comment on the present.

Gross domestic product: According to the CZSO’s advance estimate, Czech GDP increased 6.2% qoq in 3Q. The year-on-year reading eased from -10.9% to -5.8%. The second GDP reading should not bring any significant revisions. We expect it to confirm the strong economic recovery during the summer months as a result of reduced virus-related restrictions. In particular, improved household consumption and strong demand from abroad were supportive. With confidence in the economy increasing, investment activity may have grown, as well. Industry and trade likely witnessed the largest rise in value added. On the other hand, the absence of foreign tourists and ongoing social distancing led to only a modest rebound in services. The second wave of COVID will impose further losses on the economy. We thus expect the downturn to deepen back to 10% yoy in 4Q.

Retail sales: The worsening of the epidemic situation and government measures in the form of closed shops and schools most likely triggered a decline in retail sales in October. This is also confirmed by the decline in payment card transactions in the second half of the month. In addition to closed stores, the decline in consumer confidence will also be reflected in spending. For retail sales excluding car sales, we expect a decrease of 3.3% yoy after the previous growth of 0.4% yoy. Car registrations showed a year-on-year decrease of 15.6% in October, while we estimate a year-on-year decrease of 16.8% yoy for sales. The overall decline in retail sales would thus be 7.0% in October. November will bring even worse data, as shops were closed for most of the month and consumer confidence fell to a level comparable to spring levels. December hopes to improve as the epidemic subsides, but uncertainty is high.

Industrial output: The Purchasing Managers' Index indicates continuing expansion of industrial production for October. According to the automotive industry association, car production rose in October for the first time since February, when it showed growth of 2.8%. Anecdotal evidence also show that manufacturing companies have orders and an effort to increase production. From October, further increases in industrial production may be significantly reduced by labor shortage difficulties due to anti-pandemic measures and, possibly, problems with the supply of goods for further production. But so far it does not seem there has been a dramatic limitation. For October, we expect a further increase in industrial production of 2.3% month-on-month (SA). This would mean a decrease of 2.7% yoy. After adjusting for the number of working days, we expect a year-on-year stagnation of production.

CPI inflation: The question is how the second wave of the pandemic will break prices. However, we do not expect significant changes from the development in November and total inflation should slightly decelerate to 2.7%. The previous reduction in electricity prices will be slightly reflected in inflation again. We expect food prices to rise slightly, while gas station prices are rather stagnant. The main issue remains the development of core inflation and thus the impact of weaker demand on price developments. Here we expect a slight slowdown in month-on-month growth to 0.2% SA (recreation prices are not likely to rise much), which would mean a slight slowdown in core inflation to 3.6% yoy. The previous depreciation of the koruna prevents a faster decline. However, during the pandemic, the question is how faithfully the standardised consumer basket captures real developments.

CNB: The Czech National Bank is likely to leave interest rates unchanged at its December meeting. We thus expect the key repo rate to remain at 0.25%. The main reason against further easing of monetary policy is domestic inflation, which has stayed above the upper limit of the CNB’s tolerance band. The previous weakening of the Czech koruna and a smaller-than-anticipated impact of the COVID pandemic on household income have been the main factors for higher growth of consumer prices. Despite the strong economic downturn, the situation on the labour market has been favourable as the unemployment rate increased only modestly. This was also supported by expansionary fiscal policy. We forecast monetary policy interest rates remaining at current levels at least until the end of 2021. This will be due to only a gradual recovery of the economy next year. Moreover, further development of the pandemic continues to be highly uncertain. The risk of higher interest rates in 2021 mainly concerns the rapid spread of the vaccine, which could accelerate economic growth.

We initiate coverage of small firearms manufacturer Ceska zbrojovka Group SE (CZG), with a Buy rating and target price of CZK357, implying a 12m TSR of 27.9%.

We initiate coverage of small firearms manufacturer Ceska zbrojovka Group SE (CZG), with a Buy rating and target price of CZK357, implying a 12m TSR of 27.9%.

CZG is one of the leading European producers of small firearms and the largest manufacturer of firearms in the Czech Republic. The company is active worldwide, with its most important markets being the US, the Czech Republic and the EU. We believe the company has strong growth potential, especially in the US. The company is in a good position to maintain profitability in our view and to continue to generate a high level of cash flow.

The US market is the largest in terms of volume and demand and is generally expected to grow at a strong pace over the near-medium term (see page 28). CZG aims to gradually increase its market share in the US, which is the world’s largest market for small firearms, and has planned to build a new firearms factory there to enable it to better serve its customers. This should also allow CZG to compete in government tenders in the military and law enforcement segments. We believe the new facility will likely help CZG increase its market share and lead to further sales growth.

CZG also has ambitions to grow in market segments other than firearms and is aiming to expand its business in the ballistic and tactical equipment sector. CZG holds a 100% stake in 4M Systems, which designs, manufactures and sells tactical and ballistic equipment.

M&A potential CZG often emphasizes the important role played by M&A in supporting further growth. Management’s vision is for a company that is a one-stop shop, meeting demand from all market segments (firearms, accessories, equipment, ammunition etc.). We see M&A activity as one of the potential factors propelling further growth and expansion. The small firearms market remains crowded and highly competitive and CZG wants to play a major role in any possible market consolidation. We see further opportunities for it to acquire ammunition companies, for example, or specialised accessories companies.

Attractive financial profile, dividend potential CZG’s low debt and strong cash flow generation, together with expected rapid future growth, creates the opportunity for an attractive dividend payout.

Our CZK357 TP is derived from a DCF model. At our TP CZG would trade at 14.6x P/E 2020e, 16.3x (2021e), and 8.2x 2020e EV/EBITDA and 8.5x 2021e. We use a WACC in the range of 8.1% to 9.8% depending on the year and a terminal growth rate of 2%.