The Investment Column: Pennon worth holding for long term

IT consultants Cornwell joins our share portfolio - Supermarket uncertainty makes Wiseman a risk
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The Independent Online

Water company shares are meant to be low on excitement, high on dividends. The sector as a whole, and Pennon in particular, proved pretty racy last year, though.

Pennon is the company behind South West Water, and its shares gushed 47 per cent higher in 2004. In common with most of its peers, it was given permission by the regulator to raise water prices over the next five years. And unlike its peers, it received and rejected a bid approach which concentrated investors' minds on the value of its other business, the landfill company Viridor.

That combination of positives won't be repeated, but there remains a strong case for holding Pennon shares, despite its premium valuation.

South West Water has a decent record in wringing cost savings out of its business. This is vital since the regulator's five-year settlement allows higher water bills only in return for significant infrastructure investment. If Pennon is to boost its earnings beyond those assumed by the regulator, it will be through efficiency savings.

The sex, such as it is, continues to come from Viridor. It was the attractions of this business which triggered Terra Firma's bid approach last year but the private equity firm bought Shanks instead and Pennon is unlikely to get another approach now.

Operating profit at Viridor is expected to rise by a fifth again this year. The Government is discouraging landfill in favour of more environmentally-friendly waste management strategies, but the balance of measures is not yet unfavourable to Viridor. Landfill taxes are being pushed much higher, which will drive away some business, but there is also a shortage of new landfill sites, which is allowing the company to raise prices for tipping. Meanwhile, it is also enjoying tax breaks for generating electricity from the gas produced at landfill sites.

Pennon shares now trade on 16 times this year's earnings, 15 times 2006. That's too high for new investors, but those in for the long-term should hold and harvest the dividend.

IT consultants Cornwell joins our share portfolio

We are adding Cornwell Management Consultants to The Independent's portfolio of share tips for 2005. We need a new member after Harvey Nash crashed through our stop-loss limit earlier this week.

Despite having our fingers burnt once, we are tipping another potentially volatile share. Cornwell floated just last November and has already jumped from an initial 121p to 151p yesterday. We believe this momentum can be maintained.

The company was set up by a former Ernst & Young employee, Keith Cornwell, now its chairman, in 1991 to provide management consulting that was independent of any particular IT hardware or software company. Most of its work is for the public sector, with 34 per cent of fees from central government. It has particularly strong relationships with the Ministry of Defence. At the presentation of its maiden results last week the company talked of a strong increase in invitations to tender for new business, and it is enjoying something of a virtuous spiral as its growing size makes it eligible for more government work.

The company spent money last year not just on its flotation but also on hiring new consultants and they should start paying for themselves this year. A hiatus around the general election notwithstanding, more government work is assured as it acts to introduce efficiencies across the civil service.

This is a high-quality, conservatively managed company with significant scope to build market share. On less than 13 times this year's projected earnings, it is also cheap.

Supermarket uncertainty makes Wiseman a risk

Stomachs must be churning at Robert Wiseman Dairies. The Scottish group has another six-week wait before it finds out whether it is to be dropped as one of Wm Morrison's milk suppliers. And longer still before it hears whether Somerfield plans to ditch it.

Wiseman says it is optimistic that neither chain will axe it, but second-guessing Sir Ken Morrison is a mug's game. And investors are all too aware how destabilising the loss of a big contract can be: they need only look back to the collapse in the share price when Asda sacked Wiseman last summer.

Yesterday's trading update showed the extent of the progress Wiseman has made in resurrecting its fortunes, but the days of the company's heady growth as it expanded beyond its Scottish heartland look long gone. It has been a struggle just to ensure that the volume of milk sold by Wiseman will be flat in the year to end-March (at about 1.2 billion litres). This reflects the management's pugnacity, compensating for the loss of the Asda contract by grabbing more business with J Sainsbury and Tesco - although the Tesco volumes don't kick in until April. Unfortunately, it has had to sacrifice profit margin to win the business. It made 2p per litre in its second half, down from 2.5p.

Regardless of Sir Ken's decision, Wiseman is pressing ahead with new dairies in the South-east and the South-west. In an industry already suffering from overcapacity, this may serve to compound shareholder nerves, despite yesterday's reassurance that trading is in line with expectations.

The shares, flat at 269p, trade on 11 times earnings, which suggests the market is taking the Morrisons' contract for granted. Too risky.