Acquisitions keep Danka ahead

Trusts feeling the squeeze; Sage remains a rare animal
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The Independent Online
For investors who like to see solid and transparent organic growth, Danka must seem a rather hair-raising proposition. Despite narrowly failing to snap up Southern Business Group recently, during the year to March the office equipment supplier made 42 acquisitions after an equally busy 12 months the previous year.

Goodwill write-offs totalling £58m on those purchases have left the company with net assets of only £25m, despite sales in excess of £500m. Seeing what is going on is the big challenge.

Pre-tax profits, 42 per cent ahead at £45.4m, represented the eighth successive year of record results, struck from sales up by a half during the year. After a similar rise in earnings per share to 16.8p, the handsomely covered dividend rose another 20 per cent to 1.8p.

The flip side of Danka's rapid growth, which added an annualised £125m of sales last year, has been a tightening of gross margins thanks to the lower returns of acquired businesses, which tend to be less well run. Working to a strict template, however, Danka reckons to get the new businesses up to speed within six months or so.

Looking ahead there seems no real reason the growth should not continue in what is still an extremely fragmented market. Despite its number two ranking in the US and UK, behind Alco Standard, Danka commands only about 2 per cent of the market for selling office equipment, providing maintenance and supplying consumables such as paper and toner.

It is a huge market, worth perhaps $25bn in the US where Danka still does most of its business, and changing so rapidly that demand for ever- whizzier machines continues to grow.

It is also extremely cash-generative with relatively secure income flows. Danka, says more than 90 per cent of its customers renew contracts and more than 80 per cent of profits are generated from high-margin supply and service sales from the more than 300,000 machines already in the field. The stranglehold of Xerox and Kodak on the really big, fast machines at the top of the market has also started to loosen.

Danka is plainly a well-run, financially sound business operating in a growing market. It also seems to have avoided most of the bad publicity surrounding the photocopier leasing industry in this country.

On forecast profits for the year to next March of more than £60m and earnings per share of over 20p, however, the shares stand on a prospective price-earnings ratio of almost 20, even after yesterday's 35p fall to 385p. High enough.

The euphoria that propelled equities to a new peak early last year spilled over into investment trusts. But while the sector tracked the main market on the way up, it seems to have suffered disproportionately on the way down.

Since reaching a high of 182.63 on 4 February 1994, the FT-SE investment trust index has under-performed the rest of the market by just over 6 per cent, hovering around 155 currently. At the same time, the average discount to net assets has doubled from last year's historic low of 4 per cent.

The answer to the sector's poor performance may lie in savings figures published yesterday by the Association of Investment Trust Companies, which suggest that the sector has become a victim of its own success in attracting relatively unsophisticated retail investors.

The total invested in investment trust savings schemes slumped in the first quarter to £44.1m from £67.9m in the same period last year for much the same reason that unit trust cash flows often fluctuate. Lemming-like investors seem to have an uncanny knack of piling in just ahead of the top of the market and then becoming discouraged as share prices fall.

Other factors may also be acting against investment trusts this year, not least the record £8bn in new money that poured into the sector in 1994, leaving institutions more than satisfied.

The threat to tax breaks posed by a Labour government may also be a depressing influence, given the boost to investment trusts from personal equity plans. Although down on the previous year's £327m, the £266m pulled in by investment trust PEPs in the 12 months to April is more than 10 times the figure of six years ago.

These fears may turn out to be overdone, however. It is not at all clear that Labour will sweep away all the Conservatives' tax changes and some overseas investment trusts could prove a safe haven for small savers fearing an anti-business, socialist government.

There is also a silver lining to the AITC figures. Regular savers have maintained their loyalty to trusts, with the latest £21.8m figure only marginally below the previous quarter and well up on the £18.5m in the first quarter of last year. This regular drip-feed has helped close the traditional discount to net assets and will continue to underpin the sector but individual trust selection remains crucial to performance.

Sage is that rare animal: a people-based technology stock that is continuing to fulfil its early promise. Shares in the accounting software group have amply repaid the patience of investors who have stayed with it since it floated at 130p in 1989. After a leap of 87p yesterday, they now stand at 915p.

The reason for the latest rise was news of a 71 per cent jump in pre- tax profits to £11.7m for the six months to March, on turnover almost doubled to £50.6m from £25.4m before. The interim dividend rises 10 per cent to 4p.

Sage has made a virtue of its acquisition strategy, despite the bad experience of others who have bought people-based companies. Expenditure of £26.6m since August on four businesses added £19.9m to turnover and £2.7m to total operating profits. But that reflected only part of the potential, given that Saari, a French carbon-copy of Sage acquired for £18.5m, came in part-way through the period. Sales there are said to be around the level of the UK business, currently about £30m a year, but margins of 7 per cent still have a long way to go to match the 46 per cent typical in the domestic business.

After borrowing to fund the Saari acquisition, Sage showed a deficit on shareholders' funds of £14.5m in March. But £3m of the loan has been repaid and the interest charge is well covered.

With few serious competitors, the danger must be that a bigger rival moves into Sage's highly profitable niche. That remains a distant threat, however, and profits of about £21m this year still makes the shares good value on a prospective p/e of 14.