American upheavals tarnish S&N

The Investment Column
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The Independent Online
Smith & Nephew, the Elastoplast to bone replacement group, is nothing if not predictable. The shares surged earlier this year on hopes the company was moving into more exciting areas of the healthcare market. But, after peaking at 213p, they have since fallen back as the realisation grew that the group will continue to be dominated by its mundane spread of businesses.

Yesterday's interim figures, bang in line with market expectations, underlined that view. The 26 per cent growth in stated profits to pounds 91.9m in the six months to 29 June was more like 5 per cent when the figures are adjusted for the effect of exchange rates, disposals and acquisitions, of which there were three last year.

S&N has a good franchise in some of the more esoteric areas of the US market, but it is in its transatlantic operations that S&N also continues to suffer. Big mergers amongst hospital groups, such as Hospital Corporation of America and Columbia, the creation of buying co-operatives or healthcare management organisations by big corporate customers and the formation of purchasing alliances by smaller hospitals continue to put pressure on prices.

The British group remains particularly vulnerable to this upheaval. The US remains by far its biggest market, taking 41 per cent of half-year sales, of which around 60 per cent are made to big groups.

Part of the recent weakness in the shares was on the back of poor figures from US competitors. As it happened, S&N suffered a 3 per cent price fall in the US in the latest period, twice last year's rate, but did well to more than make that up with a 4 per cent volume increase, helping, with cost savings, to maintain margins.

The group is cautiously suggesting prices could soon start moving in the right direction and argues that as a big global group it should benefit from this rationalisation in the long run. But it concedes it could be another couple of years before the US market is out of the woods.

Meanwhile, the potential of Dermagraft, a skin graft product, and other biotech ventures will take a while to be realised. Sales of anywhere between $200m and $500m for the diabetic ulcer market by early next century would transform the group, particularly as new products currently enjoy a 5- to 10-point margin advantage over existing lines. But selling the benefits and educating the market could take longer than with traditional products.

Short-term interest is therefore likely to centre on takeover prospects both by and of the company. With cash firepower of up to pounds 500m, and the potential to issue shares over and above, S&N is plainly capable of raising its world ranking from five or six to number three. On a prospective price/earnings ratio of 16 at 195p (forecast profits of pounds 190m this year, rising to pounds 202m next) last year's speculation that the company would be taken out looks to be fully in the price. One to tuck away.

WPP set to win

Sorrell his bonus

Martin Sorrell's bet that he could drive the WPP share price hard enough to activate his lucrative share option package is poised to be won, thanks to yet another strong set of results yesterday.

The shares are just 9p shy of the 230p needed to give Mr Sorrell his second tranche of shares, while the first target of 198p has held nearly long enough to put him in the money. Supporters of such long-term incentive plans will point out that shareholders will have gone along for the ride, seeing their shares rise from about 120p when the pay deal was reached last June to 221p yesterday, up 7p on the day.

If the company continues its present run, the 304p upper target, by 1999, looks eminently achievable, giving Mr Sorrell a whopping pounds 25m. But that would mean WPP would be worth about pounds 2.2bn, compared with just under pounds 1.6bn today.

Whether that is fair justification for paying anyone such a mind-boggling sum is a moot point, but it is hard to fault the internal logic of the scheme. Mr Sorrell is at least being rewarded for overseeing a massive increase in shareholder value, which is what he is employed to do.

Yesterday's results for the six months to June saw profits jump 40 per cent to pounds 68m, on revenues ahead 10 per cent to pounds 833m. The gains came from new accounts, always a reassuring thing for an advertising company, but also from Mr Sorrell's incessant cost-cutting, suggesting that new business won in the future could find its way more easily to the bottom line. The target of 10 per cent margins, set by Mr Sorrell last year, was easily achieved, which also bodes well for the future.

Even more impressive was the return to profitability of Hill & Knowlton, the public relations arm, which has long been a source of concern for WPP management. Most analysts had not expected the improvement to come so quickly.

WPP is one of those companies that perhaps ought not to be quoted at all. Its prospects are wholly tied up with its highly mobile creative staff, and the assets leave the building every night. But the market for advertising (WPP owns Ogilvy & Mather and J Walter Thompson) looks like having a good run this year and next, while market research, in which WPP has a leading reputation, can be highly profitable in periods of good economic growth.

Certainly the City expects continuing good fortune, with full-year pre- tax profits likely to hit pounds 155m, or 13p a share, implying a multiple of 17. Next year, the expectations are for pounds 186m of profit, or 15.4p a share and a p/e of 14. Still good value.

Education boom

benefits BPP

BPP Holdings, the educational and publishing group, is benefiting from the boom in professional qualifications. With the educational market becoming increasingly complex and with seemingly every other college turning itself into a university, professional qualifications are gaining in stature.

Add to this, growth in banking courses in areas such as derivatives and BPP is in a very strong position. As the market leader in helping white collar workers and students pass exams through its college courses and textbooks, growth in professional recruitment is good news. It is a leading training provider for certified and management accountancy course and has recently expanded into law, medicine and the City.

The favourable market conditions helped lift BPP's profits by more than 10 per cent to pounds 4.6m in the six months to the end of June on sales up from pounds 30m to pounds 35m. The Letts Educational publishing business has been boosted by the national tests for 11- and 14-year-olds, though the Blackstone lay publishing division hit a dull retail market. In professional training, new courses have been introduced and the company has training centres in Luton,Reading and Southampton. One of the most encouraging signs of these results was the improved performance of the language training division, Linguarama, restored to profit last year following disposals in Japan. Sales were up strongly at the interim stage though margins remain tight. The UK, France and German centres performed well though the centre in Russia is not yet in profit.

The weak link this half was academic education where profits were flat. Much will depend on enrolments in the new academic year which starts in September and October, but BPP appears in good shape. The shares have risen from 178p two years ago to 383p, unchanged yesterday. With full- year profits of pounds 9.4m expected they trade on a forward rating of 17. That is not cheap compared with expected earnings growth over the next two years of only about 10 or 11 per cent a year and the shares look to have enjoyed the best of their run.