The Investment Column: Dairy Crest is the cream of the crop - but still only a hold

Punch Taverns; XP Power
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The Independent Online

Our view: Hold

Share price: 591p (-40p)

Dairy Crest yesterday broke into the French market by acquiring rival Uniq's Saint Hubert spreads business for £248m. The deal, which gives the company a number two spot in France's spreads market, is to be financed by a new £200m debt facility and a £35m placing of new shares at 600p. It is the latter that depressed Dairy Crest stock yesterday.

Nevertheless, the purchase makes great strategic sense. St Hubert controls 31 per cent of the spreads market across the Channel and 35 per cent of the healthy spreads category, which is growing at 10 per cent a year. More importantly, it means that Dairy Crest now generates between 70 and 80 per cent of its profits from branded products.

The group was clever to realise some years ago that focusing on branded diary food rather than the low-margin business of supplying own-label products to UK supermarkets was the best way to secure its future prosperity.

The City certainly agrees. Even after yesterday's retreat, Dairy Crest shares are still up by more than 25 per cent - on past six months alone.

Among the group's most famous brands are Cathedral City mature cheddar cheese, which is bigger than tomato ketchup in the UK, Utterly Butterly spread and Country Life butter.

Swallowing St Hubert is Dairy Crest's first notable venture outside the UK. Although the track record of British food companies in France is rather patchy, the group's projections look positive.

Dairy Crest is buying St Hubert at 11 times earnings and forecasts the deal to boost its earnings by 7 per cent in the first full year of ownership.

The group was also able to unveil a 25 per cent rise in first half pre-tax profits to £31.8m yesterday. Given the company's top range of brands, the premium to the wider sector at which Dairy Crest stock is trading is justified.

Punch Taverns

Our view: Hold

Share price: 1,089.5p (+28.5p)

Punch Taverns, Britain's biggest pub landlord, with over 9,200 pubs, managed to beat City expectations in what has been an extremely eventful year for the company. Annual sales doubled to £1.5bn after the Spirit acquisition, pushing the firm's pretax profits up 21 per cent to £250m.

Punch has been busy integrating the 1,800-strong Spirit estate which it acquired in January. On top of that, it has had to deal with the smoking ban in Scotland that was introduced in March, ahead of a nationwide ban due to come into effect next June.

Punch breathed a sigh of relief as sales North of the border have held steady since smokers were banished from pubs, but the winter could prove to be the real test when it gets too cold for people to nip outside for a cigarette. Income from machines has already taken a severe hit, falling 8 per cent across the managed estate, though food sales have risen.

Giles Thorley, the company's chief executive, was characteristically bullish and said that he was looking forward to next year with confidence. People now know what to expect and are beginning to appreciate a smoke-free atmosphere, he argued.

Questions have been raised about the move into managed pubs with the Spirit deal, but Punch would be more than happy to sell the remainder - for a premium price.

While next year's smoking ban remains a concern, the stock is a hold.

XP Power

Our view: Hold

Share price: 405.5p (-27.25p)

XP Power supplies the hardware that goes into electrical equipment to convert the electricity supplied down the mains into a usable form. Sony, Toshiba and Philips make their own components, but outside the consumer goods industry it is often not economical for manufacturers.

XP supplies the medical devices, defence and avionics and communications industries and, as yesterday's trading statement showed, it is doing rather well. The update to the City said annual results to December 2006 would meet expectations, with earnings in the second half set to be higher than in the first half. This will mean the group has enjoyed compound earnings growth of 20 per cent over the past three years.

XP Power produces a growing amount of its hardware in Asia. This has been great for its profit margins. The company plans to speed up this trend and will soon relocate its head quarters and certain supply chain activities. The move will not affect its London listing, but should see it enjoy a much more favourable tax environment.

The only blot on the company's copy pad is its UK business, where trading has been weak of late. Nevertheless, its continental Europe and US operations have continued to fire on all cylinders.

For 2006, the group is forecast to make a profit of £9.1m, rising to £11m next year. This leaves its shares standing at 11-times forward earnings and yielding more than 4 per cent.

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