Aluminium looks good for Billiton
The Investment Column
Thursday 28 August 1997
After a shy start, shares in Billiton, the base metals company recently demerged from South Africa's Gencor, are gaining confidence. Floated at 220p at the end of July, Billiton's share price closed yesterday at 248p, pushed 6p higher by competent pro forma full-year figures and positive noises from analysts. There are good reasons to keep faith.
In themselves, yesterday's sketchy, unaudited numbers included in Gencor's full year figures to June, were no more than reassuring. Unsurprisingly Billiton beat its own US$330m flotation forecasts, reporting pre-tax profits up 4 per cent to $335m. The 43 per cent jump in aluminium profits, over 45 per cent of the total, to $193m reflected full inclusion of associate Alusaf and the fall in ferro-alloy profits was flagged. Billiton's audited figures, reported on 2 September, will be more meaningful.
The argument too that Billiton's share price will be driven by its imminent inclusion in the FTSE and the need for tracker funds to buy is weak. True, capitalised at over pounds 5bn and with a primary listing in London, Billiton is likely to join the FTSE club, even though 70 per cent of its profits are made in South Africa. UK tracker funds are still short of Billiton's shares, given the strong South African shareholding. But extractive industry stocks represent a small fraction of the total UK stock market - around 1.5 per cent - so fund managers need not rush to buy.
More compelling is to look at base metals prices, particularly when comparing share ratings for Billiton, an aluminium player, with UK rival Rio Tinto, which makes around 40 per cent of its profits from copper. Copper and aluminium prices have been heading in the opposite directions. The price of copper has been steadily falling. With the operating costs of producing copper considerably less than the copper spot price, players have expanded capacity. The pressure on prices is likely to put a brake on Rio's earnings growth.
Aluminium is in better shape. A glut of the metal in the early 1990s hit prices, leading to a cartel of the big players, agreeing to cut capacity.
Enduring caution about oversupply, plus high operating costs relative to the metal's spot price, should keep aluminium prices firm. So will growing demand in US packaging and the automotive, aerospace and building industries - all heavy users of aluminium.
On UBS's numbers, Billiton is currently rated at just over 15 times forward earnings compared to 16.5 times for Rio and 14 times for the extractive sector. A discount to Rio is not inappropriate.
Billiton is a less diversified company and needs to prove itself outside South Africa. But Billiton's management is aggressive and, with proceeds from the float, has the firepower and appetite to diversify. It has already outlined bold expansion plans in the nickel, coal and copper markets. Given that and prospects of faster earnings growth than Rio, Billiton's discount to Rio should narrow. Good value. Kalon, the Yorkshire-based paints group, has been an erratic performer since its merger with Euridep, the French paints subsidiary of Total, two years ago.
Shares in the group have sunk from 160p to barely over 100p towards the end of 1995, before recovering strongly this year.
The price perked up another 9p to 171p yesterday on the back of a 24 per cent increase in first-half profits and news of greater cost cutting at the merged entity.
At the time of the deal Kalon said it anticipated pounds 10m total cost savings. Yesterday it revised that to pounds 23.5m savings by 2000. Most of the additional benefits will come from France as the UK restructure is already completed.
Kalon's performance has been creditable given the unfortunate timing of Euridep, a deal giving Total a 66 per cent holding.
The French economy hit the skids almost as soon as the merger was consummated. Managing director Mike Hennessy estimates the economic downturn in France has knocked pounds 10m off profits with no sign of an upturn.
As France is the group's largest market, Kalon has had to work hard to achieve growth with most benefits coming from cost cutting and in-fill acquisitions.
The hike in interim profits to June to pounds 24.4m was achieved in spite the strong pound. This knocked 10 per cent off sales, but shaved just pounds 1.8m from profits.
Though France remains grim, the UK is showing signs of life. UK sales were 5 per cent down due to the previously announced loss of some private- label contracts.
Sales of decorative paints to DIY sheds such as Sainsbury's Homebase and Do It All rose by 4 per cent. This is the first glimmer of hope in the market for several years.
But the limiting factor for Kalon is that though house prices have risen strongly in the South-east, the relatively low level of housing transactions has kept the lid on sales.
In France margins are ahead but trade volumes have been badly hit by lower government spending.
On the acquisition front, talk of a foray into the US was dismissed by the company yesterday. Kalon is more likely to concentrate on Europe, where it is already the second-largest paints group. Germany, which is the largest paint market in Europe, should be the next target.
On full-year forecasts of pounds 45m, the shares trade on a forward rating of 22 falling to 18 times. High enough.
Time that Marley
With the housing market and the commercial property sector taking off it is logical to assume that the building material sector should also be booming.
So why then has the materials sector fallen by more than 5 per cent in the last year at a time when the stock market has raced away?
The simple answer is that many of the building suppliers went overseas to try to escape problems at home when the housing market fell into recession in the early 1990s. That was fine while continental European markets were flourishing. But the strong pound and an alarming tail-off in important markets such as Germany has put a real dent in profits.
Marley, which sells everything from roof tiles to plastic drainage and plumbing systems, has been one of the worst casualties. Its shares, which slipped another 5.5p to 109.5p yesterday, have plunged from 140p last October.
However, the fall looks overdone. True, sterling's strength knocked pounds 2.3m off profits in the six months to June and hit exports of flooring products to Germany. Even so, underlying profits rose 11 per cent to pounds 28.8m, ignoring the one-off profit the company made from selling its automotive business last year.
Strong growth in housing starts in Britain, forecast to rise by around 10 per cent this year, is helping Marley's blocks and roof tiles business and it should be able to make price rises of 10 per cent stick this year.
The rate of growth will no doubt slow, but the market looks set fair for the next few years.
Syroco, the US plastic furniture manufacturer bought in 1995, has been a serious disappointment due to an indifferent US retail market.
The episode gives little confidence that Marley, which is on the hunt for more acquisitions, can spend its money wisely.
That said, the recent purchase of Flexco, a US flooring group, looks promising, and the worries are more than reflected in Marley's low rating. Analysts are forecasting full-year profits of pounds 50m, putting the shares on a prospective price/earnings ratio of 11. Good value.
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