The Investment Column: HMV sounds good for more growth

Sopheon is a buy for the high-risk investor; Gallaher's expansion prospects fail to excite
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The Independent Online

This will be the year that the mighty force of UK consumer spending finally thumps into the immovable object of £1 trillion of personal debt. It has been the most common of pundits' predictions for the year and, even if the resultant slowdown is gentle, rather than apocalyptic, you probably don't want much of your investment portfolio in the retail sector.

This will be the year that the mighty force of UK consumer spending finally thumps into the immovable object of £1 trillion of personal debt. It has been the most common of pundits' predictions for the year and, even if the resultant slowdown is gentle, rather than apocalyptic, you probably don't want much of your investment portfolio in the retail sector.

But you might want to keep a little in HMV shares. The company, which owns the eponymous record shops chain and also Waterstone's bookstores, sells relatively cheap items to people for whom books and music and movies are an important part of their lives. It ought to prove relatively resilient in any downturn, even more so this time because the DVD market is still new and growing fast.

Yesterday, the company put out its interim results and an update on trading in the subsequent 11 weeks to 8 January. They weren't great, frankly, although the growth in sales over Christmas was much better than many, taking their cue from Woolworths and Ottakar's, had feared.

Operating profit was flat only in the six months to 23 October, as the company booked the costs of opening new stores, including the massive Waterstone's on London's Oxford Street. But 85 per cent of group operating profit is made in the half-year including Christmas. At Waterstone's, festive discounts on TV tie-in books from Jamie Oliver and Michael Palin were the inevitable result of competition from supermarkets. But at HMV, profitability was in line with expectations.

Alan Giles, the chief executive, sounded the necessary notes of caution on consumer spending. But whatever happens, he has the cash to continue expanding the HMV chain by 25 a year, while the performance of Waterstone's has also been turned around and it can now be expanded. All this and a £50m share buy-back programme.

We have said buy on four occasions since the flotation and, on 11 times calendarised 2005 earnings, we think there is still more to go for. Buy.

Sopheon is a buy for the high-risk investor

Sopheon's software helps multinational companies kill off their duff new product ideas before they spend too much money on them. It assimilates information on the product market, likely pricing and competition issues, and also ensures that different bits of an organisation are not duplicating product development work. The software is called Accolade.

It is the one fruit of years of effort at this company, which has had to be restructured and refinanced to make it viable. It had its first cash-positive quarter in the final months of 2004, although bottom-line losses will continue for most of this year. Yet there are encouraging signs of take-up from the chemicals and drug industries. The bundling of the software with Microsoft's is also a positive development that should keep up the sales momentum.

There are a couple of warning lights flickering amber, though. Sales growth was a little shy of forecast, as one licence sale slipped into 2005. And the company's auditor insisted it say that all the trading update's figures are "subject to the completion of the year-end financial close process", suggesting discussion over accounting issues.

This ought to put off the cautious investor, but Sopheon isn't for them. This is high risk, high reward, and worth a punt.

Gallaher's expansion prospects fail to excite

If you can't beat 'em, join 'em. The number of cigarettes sold in continental Europe by Gallaher, the company behind Silk Cut and Benson & Hedges, has been hit by the flood of cheap imports from eastern Europe. So the company is cutting 250 jobs in the UK and Austria, it said yesterday, and shifting manufacturing to the cheaper labour markets of Romania and Poland.

The shift is also part of the Great Tobacco Chase, where companies are racing to the East. They must do so, as health campaigns and tax hikes in the West cut the numbers of us puffing our lives away. This will, however, be a slow process. Gallaher has a partner in that most potentially lucrative emerging market, China, but the authorities are getting defensive of their local industry and full exploitation of the market looks difficult for now.

And Gallaher is going to be dominated by the West for a long time. A partial ban on smoking will start in the UK in 2009 and similar ideas are gathering momentum across Europe. Italy, the second biggest market after Germany, began its public ban this month.

With an addicted customer base, Gallaher can continue to increase prices, and the cash will keep rolling in. But investors have prized that sort of cash generation very highly in the past year or so. The dividend yield is down to 4.3 per cent and the share price-to-earnings ratio of 13 suggests little more room for capital growth. The possibility of a takeover from Japan Tobacco has sent the stock up 16 per cent since we said hold last May, but the chances of a bidder paying a premium for a business facing further regulatory restrictions seem low. Quit.

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