The Investment Column: Defensive business DS Smith packs a real punch

Moss Bros; Probability
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The Independent Online

Our view: Hold

Current price: 212.25p (+6.5p)

Perhaps it is difficult for anyone outside the industry to get excited about the paper and packaging sector. As a result, DS Smith is often overlooked, but for canny investors that could mean a decent opportunity to get into a well-managed, well-priced stock with solid prospects.

Higher selling prices offset rising input costs and management initiatives resulted in an excellent showing at the half-way stage.

Interim pre-tax profits rose by 44 per cent to 56.1m on the back of an 8.5 per cent increase in revenue to 942.7m.

The company operates four main divisions UK paper and packaging; European paper; plastics packaging and office products wholesaling.

The star of the show is UK paper and packaging, which delivered sales of 367.1m and earnings of 39.9m in the first half, the latter almost trebling over the same period of 2006 despite relatively flat sales. Raw material cost pressures are likely to remain in place for the second half and management will need to be on its toes to maintain margins. In fact, all of DS Smith's business outperformed market forecasts in the first half, the only blot on the numbers coming from flat earnings at the European paper division.

A cautiously optimistic outlook statement from the company sounds about right, in spite of the strong first-half results. If input costs continue to increase and energy costs rise sharply over the winter, it will be difficult to maintain margins by passing price rises on to customers. However, this is an encouraging first half to the year for a company that deserves better coverage.

The shares trade on just 10.2 times forecast 2008 earnings, yielding 4.2 per cent. That is good value for a relatively defensive business with innovative, experienced management. DS Smith is not going to make anyone rich overnight, but in the long term these shares are worth tucking away. Buy.

Moss Bros

Our view: Sell

Current price: 36.5p (-1.5p)

The signs do not look good for one of the UK's most venerable high-street tailors. Yesterday's profit warning from Moss Bros should not have come as much of a surprise to investors, and as the shares only fell 4 per cent it is fair to assume the market wasn't expecting good news. But where does Moss Bros go now?

The numbers themselves have already been well covered elsewhere in this paper, so there is no point in going back over them. Like-for-like sales are falling, full-year results will be below forecasts and unless the company has a stellar Christmas the situation does not look like it will improve any time soon.

The truth is that, in our opinion, as a brand and as a business Moss Bros is facing an uncertain future, to put it mildly. Its menswear selection is not appealing to young trendies or even old fogies, and the competition is likely to prove too tough to beat. Anyone wanting a dinner suit can buy one for 35 at competitors such as Asda, so why would anyone rent one? Its more regular business attire should show improved performance as it incorporates better known brand names, but really the only part of the business that is standing up to the onslaught is the wedding hire unit, which is hardly going to drive growth on its own.

Moss Bros is still generating cash and has more than 16m in the bank and no debt to speak of. But it does not own any of its retail space so there is no property to fall back on or support the valuation and it feels like Moss Bros is stuck in a time warp.

Sad though it is, we cannot see any short-term reversal of fortunes at Moss Bros. The store refurbishment and range changes may deliver eventually, but in this environment it is hard to see any short-term improvement. Sell.

Probability

Our view: Risky buy

Current price: 41p (unch)

Us Brits will have a punt on just about anything apparently William Hill will give you odds of 2,000-1 that LaToya Jackson and Michael Jackson are the same person. Not content with gambling at high-street bookies and in virtual internet casinos, gamblers can now even have a punt on the move via their mobile phones .

Although it is still a tiddler, the AIM-listed Probability is the UK's largest provider of phone-based gambling software and services. Yesterday's full-year results were in line with forecasts and the company remains on target to break even on schedule.

First half pre-tax losses of 624,000 were down from 1.6m in 2006 and the company achieved its first profits, at an operating level. Net gaming revenues jumped 83 per cent to 1.2m while the company's "Lady Luck" game has signed up another 24,000 players since the end of September.

Despite hitting all of its targets and signing new deals with the likes of The Sun, Blue Square and Orange, shares in Probability have been a pretty poor bet so far, losing half of their value since the float last August. But that should change over the next year or so as the company moves into profit and continues to deliver on its pre-listing potential.

With enough cash to see it through to profitability, Probability looks ideally positioned to benefit from the next phase of the gambling industry revolution. Although it has obvious risks, Probability looks a much better punt than speculating on Michael and LaToya Jackson's real identity.

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