The Investment Column: Pricey Carpetright a hold at best

Expensive ITM Power still looks a long way from generating profits; Time to log off from SurfControl
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The Independent Online

Shares in Carpetright, Britain's biggest carpet retailer, had a strong run before yesterday's trading update. And the FTSE 250 company did not disappoint investors as it made clear it has bounced back after suffering tough times because of the recent housing market slowdown.

In fact, under the rule of Lord Harris of Peckham, the group has proved remarkably resilient at a time when many other retailers struggled and sellers of home furnishings were extra hard. Although Carpetright suffered a 30 per cent fall in first-half profits, it continued to take market share from smaller rivals and has successfully adjusted its cost base. Rental costs are coming down as the company is moving to cheaper sites and opening smaller stores.

The update yesterday showed like-for-like sales have turned positive again: they were up 0.2 per cent in the first 12 weeks of the second half. While the figures were flattered by weak annual comparisons, they do point to an improving sales picture. All the evidence suggests the housing market has turned the corner after last year's sharp slowdown. Carpetright should be a main beneficiary, with 15 to 20 per cent of its business directly related to people moving house.

Gross margins are recovering after Lord Harris abandoned a rather unfortunate price-discount strategy designed to attract shoppers during a time of consumer caution. Carpetright offered massive discounts but failed to attract new buyers, meaning those who did buy got their carpets for a lot less, which ate into the company's margins. Going forward the company should also benefit from a more prominent advertising campaign.

Lord Harris, Carpetright's founding chairman, chief executive and a 23 per cent shareholder, has been rumoured to want to take the company private, but there is no evidence that this is imminent.

Carpetright is in a good market position but its shares are expensive compared with its rivals. Trading at 19 times 2006 earnings, it is a hold at best.

Expensive ITM Power still looks a long way from generating profits

With the price of oil close to record highs and suggestions that global production of the commodity has now peaked, the number of renewable energy companies has mushroomed.

Among them is ITM Power. It believes that hydrogen is a good alternative to crude and is in the process of developing a series of products which can exploit the chemical element.

Hydrogen can be stored or burnt in a combustion engine or converted to electricity through fuel cells. The problem is that it is difficult and expensive to produce in an environmentally friendly way and that fuel cells, one method of turning the element into power, are also costly.

In this industry, the prize will be taken by the player who can make both commercially viable. And it is certainly a big prize. ITM Power says it is looking to win a piece of what one day could be a trillion-pound market.

The group seems to be leading the pack on this front, and by June it hopes to tell the City whether its Electrolyser can make hydrogen as cost efficient as fossil fuels. ITM believes cars and backup power systems could be among the first to run on hydrogen produced by it.

But that is a long way off. Although ITM set out a timetable yesterday for the development of its technology, it is clear that the group is some way away from being in a position to generate revenues from let alone profits.

At 203p, yesterday's closing price, the company is valued at £179m, which looks expensive given its distance from profitability.

Time to log off from SurfControl

SurfControl develops and sells software designed to block unwanted internet content such as junk e-mails and pornography.

Yesterday's results from the group, which boasts the likes of Ernst & Young and Juventus football club in Italy as customers, revealed a first-half loss of $610,000 (£340,000) compared with a profit of $3.3m for the same period last year. To blame were restructuring costs which were aimed at streamlining the business and boosting its sales staff.

As it turned out, these costs came in well above market expectations. SurfControl's sales growth also failed to impress the City. The software group reported a 2 per cent year-on-year increase which was achieved only because it sold a greater number of products to existing customers. This is clearly not a sustainable path to growth and leaves the company very much in need of winning new customers.

Patricia Sueltz, the group's chief executive, admitted yesterday her company's growth rate was well below that enjoyed by the wider industry.

Meanwhile, SurfControl stock trades on a heady multiple of its earnings. At a closing price of 567.75p yesterday, its shares are at 32 times forecast earnings for the full year. That is simply too high a rating, especially for a company which is underperforming its rivals. Sell.

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