The Investment Column: 3i well-placed to ride out any storm in private equity

Barratt Developments; Tullow Oil
Click to follow

Our view: Hold

Current price: 1145p

3i is the acceptable face of private equity. A FTSE 100 index constituent, its chief executive, Philip Yea, earns millions rather than squillions, pays UK income tax and runs a company whose activities are about as transparent as it gets in this often murky world.

It also does a lot of work funding small and fast-growing companies - the traditional form of venture capital that everybody agrees is a jolly good thing.

Yesterday, at the company's annual meeting, 3i said realisations from its investments in the first quarter were well ahead at £605m compared with £433m in the same period last year, while new investment in private equity stood at £410m compared with £240m.

That update follows a very good set of full-year figures, when 3i said it had realised £2.4bn from investments, against £2.2bn. The 2005 figure had been thought unsustainable, but clearly the private boom was running at full steam in 2006 and the company beat its own expectations.

Whether it can continue this, however, is open to question. While politicians and regulators are busy huffing and buffing, some banks, at least, are beginning to get cold feet about lending private equity firms money on the terms they want. An attempted buy-out of New Look has already failed, and it would only take one or two deals to go wrong for the more nervous - or perhaps sensible - to decide that enough is enough.

It is not as if 3i's shares are cheap. They trade at a premium to the value of 3i's investments - estimated to be 970p-980p on 30 September 2007 and £10.35 to £10.45 on 31 March 2008 - after taking into account a planned £800m return of cash to shareholders. But if there is a storm, 3i should be in a better position than most to weather it. Hold.

Barratt Developments

Our view: Hold

Current price: 969p

For an industry that sells a product where demand massively outstrips supply, housebuilders trade on remarkably cheap valuations. Barratt Developments is no exception - at the current price, the stock trades on a rating of just over seven times forward estimates of earnings, broadly in line with peers.

Plainly, the risk for all housebuilders is that interest rate rises - and there may yet be more hikes, despite the five increases we've had since last August - choke off the property market. In yesterday's trading update, Barratt warned "it would be prudent to assume [that] the housing market will tighten".

Tightening is not the same thing as a slowdown, however, let alone a crash. And there's no getting away from the numbers. Last year, the private sector built 160,000 new homes. Economists believe 223,000 were needed.

In such a marketplace, a housebuilder that pays close attention to cost and has a decent number of plots on which to erect new properties is well placed. And Barratt is one such company.

Yesterday, it reported an increase in the size of its landbank and announced it was on target for synergies of £45m a year after the integration of Wilson Bowden, the rival housebuilder it bought last year.

Another interest rate rise would represent a setback for Barratt, but there's a decent yield - around 4 per cent - to compensate for that risk. A long-term building block for your portfolio.

Tullow Oil

Our view: Buy

Current price: 522.5p

Tullow Oil is blowing cold on the North Sea, cutting back on drilling to boost exploration in Ghana and Uganda.

The net result is that it will miss production targets for 2007, it said yesterday, but when you have just made your biggest ever discovery in Ghana, who cares?

With operations in the North Sea, Africa and South Asia, Tullow has built up a diversified portfolio of attractive, low-risk assets.

Total oil production increased 11 per cent, to 69,700 barrels a day, in the first half, fetching $61 a barrel before hedges and $57 after.

However, Tullow was able to sweeten the not-so-good news that average production for the year of 72-75,000 barrels would fall up to 5,000 short of targets by revising estimates for the size of the recent Mahogany discovery offshore Ghana. Reserves could be more than the 600 million barrels forecast, making it easily one of the biggest oil finds in Africa in recent times, although it could be some years before the oil begins to flow.

On top of that, the well extends into the neighbouring Deepwater Tano block that Tullow also co-owns with the US group Anadarko Petroleum. Drilling work will now get underway earlier than planned.

Tullow's lucky streak in Uganda continues with further drilling success. The upshot of all this is that Tullow is throttling back production in the North Sea to 28,000 barrels.

The dip in production caused a knee-jerk response in the shares, leaving them a few pence weaker yesterday, but upping Ghana's prospects could trigger broker price target upgrades to around 600p a share. Tipped here at 368.75p in late March, the shares have further to go.

Comments