Derek Pain: This ugly duckling has a good chanceto become a swan

No Pain, No Gain
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The Independent Online

I doubt if Mears welcomes being bracketed with an ugly duckling, even a famous one. Yet Liberum Capital has used the title of the famed Danny Kaye song to describe the plight of the support services group's shares.

They have endured a rather uncomfortable run, but the stockbroker's analysts believe the outlook is much brighter thanthe stock market believes, and there is every chance the shares could turn into the City equivalent of the old Hollywood star's handsome swan.

At the turn of the year the shares were riding high, stretching to 326p. In March the group produced year's results that were not universally admired. Voices were raised about the treatment of pension cash and what was perceived to be less than impressive growth. There was also talk that the long, seemingly never-ending round of government cost-cutting could impact on the company. Not surprisingly the shares tumbled, at one time falling below 240p.

Gradually a degree of optimism returned. As I write the shares are around 282p.

The no pain, no gain portfolio paid 272p in March, 2008. It was the second time that Mears had been recruited. In the earlier involvement the portfolio more than trebled its money. So far no such luck this time.

Liberum – Latin for independence – has moved to assure investors that the shares are worth buying and has tagged a 320p target price on them. The analysts William Shirley and Joe Brent say Mears, mainly a social housing and home care operator, is an out-of-favour stock in an out-of-favour sector. They believe investors are "attributing little value to the exceptional growth record, high visibility and defensive revenues". And, expounding the ugly duckling theme, the Liberum analysts say the underlying quality of earnings is not appreciated, and nor is the robust cash flow. Commenting on the controversial pension contribution, they say the stock market has become "over-focused" on this one-off action.

Expanding on the quality of Mears' operations, the Liberum researchers report that only one of the group's 10 major contracts (representing 3 per cent of turnover) is due for renewal in the next year. They expect "resilient" interim figures later this month, and year's adjusted pre-tax profits of £33.8m against £28.9m. Next year's out-turn could be around £37.2m.

An intriguing Liberum suggestion is that Mears, which has displayed predatory tendencies, could itself become the subject of a takeover strike. "We do not believe management is wedded to maintaining a stock market listing", say the analytical duo, citing Balfour Beatty, MITIE and private equity groups as likely bidders.

Two constituents I discussed last week have added to our store of knowledge. The brewer Marston's rolled out an upbeat statement, with the chairman, Ralph Findlay, describing trading as "encouraging and robust". Profits, he added, were running in line with expectations.

But Patsystems followed its planned takeover of an American group with an uninspiring half-time report. The US acquisition won a round of applause, but lower interim profits have eroded enthusiasm. The shares have slipped back, with particularly heavy turnover on Monday. The one bright spot is a 10 per cent dividend increase to 0.22p a share. Turnover shaded to £9.7m and the adjusted pre-tax profits come out at £600,000, down from £1m. The clear pre-tax figure is a miserable £159,000 against last year's £629,000. It, therefore, seems highly unlikely that the group, specialising in computerised derivative trading platforms, will even match the pre-tax return of £3.2m achieved last year, which was down from a corresponding £4.5m.

The US takeover will take the group into equities and options, broadening its operations. And the chairman, Richard Lake, seems far from downhearted. He points out that reliance on one-off deals has been reduced, and observes: "The business enters the second half of this year with a strong sales pipeline and a significantly strengthened recurring revenue base."

Finally, Avation, which joined the portfolio at the same time as a current takeover victim, Capital Pub Co. Slater Investments, the unquoted City group run byMark Slater (son of the legendary Jim) has put together a 4 per cent stake in the aircraft leasing group that recently raised £10m through a share placing. Avation has close links with the Australian airline SkyWest. The shares are now around 103p after flying as high as 120p.

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