The Investment Column: Retailers to be avoided in the run-up to Christmas

Strong demand for its microchips makes Wolfson a long-term gem; Xansa looks good for this year and beyond
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The Independent Online

Retailing shares have performed worse than the wider stock market in November and December for each of the past three years. Expect the run-up to Christmas 2005 to be just as miserable, as investors fret that the UK consumer will continue to play Scrooge.

This is the starting point for a useful piece of analysis from ABN Amro, which has come up with a list of retail shares that you should avoid, or that the more adventurous speculators might want to short for the festive season.

Of course, retailers have underperformed the market for the whole of this year already. The sector is down 12 per cent compared with a 7 per cent rise for the FTSE All-Share. But there are reasons to stay nervous. The trend for more people to leave present buying to the last minute is down to our increasingly busy lives, but this year could be even worse, ABM believes, because Christmas falls on a Sunday. For clothing retailers, an added complication is the later start of the winter season, delayed by the mild autumn weather, which must mean stock levels are higher than retailers had planned and could mean they are forced into pre-Christmas sales. And since last Christmas, energy and wage costs have risen, eating into profits.

So what are the riskiest retailers to own now? The top graphic shows how important Christmas trading is to the companies analysed by ABN, in terms of turnover and earnings. The nearer the top right, the more financially dependent the company is on the next few months. No surprise to find gift stores such as Woolworths up there.

The second graph shows companies' sales growth last year, the theory being that the better it was, the tougher it will be to make progress this year. In particular, HMV has a seemingly impossible hill to climb now that DVDs have gone into reverse. And the third graph shows the share price relative to last year's earnings. The most expensive shares have furthest to fall and while it shows the market is already pricing the riskier shares more lowly, this only limits - rather than removes - the downside if trading disappoints. Game's high multiple is deceptive, since earnings are expected to rebound this year, but delays to console launches mean that its shares look vulnerable too.

ABN's analysis suggests that the gift and specialist retailers (HMV, WH Smith and Woolworths) are most at risk in the run-up to Christmas. It also shows Body Shop International, despite its renaissance, now looking surprisingly vulnerable. Only 61 shopping days to go...

Strong demand for its microchips makes Wolfson a long-term gem

If you have an iPod or a TomTom satellite navigation system or a Sony PlayStation Portable, you are enjoying the benefits of a microchip designed and supplied by Wolfson Microelectronics, a profitable Edinburgh company quoted in London with a market value of £265m.

Its technology converts digital signals into analogue, enabling decent quality sound on consumer electronics devices. The company floated in 2003 just as MP3 players were really taking off.

The portable device manufacturers reckon on continued strong demand, and so have been ordering extra shipments from Wolfson, more than offsetting lacklustre trading in the company's older business supplying chips for DVD players. Yesterday, it said its latest six-month revenues would be $90m (£51m), rather than the $79m expected by the market, with no decline in profit margins. The shares have moved back decisively above their float price of 210p, and were up 22p to 238p as brokers raised forecasts for this year and next.

Wolfson shares have been all over the place since the float. Financial results have been erratic. A patent infringement case emerged but was won. We're sticking by our float-day tip of the shares as a long-term gem. Buy.

Xansa looks good for this year and beyond

Last week was the worst for the UK stock market since the end of the last bear market in 2003, and the sea of red carried ITV, one of the most volatile FTSE 100 shares, below the stop-loss limit that triggers its ejection from The Independent's portfolio of tips for 2005. It had fallen 18 per cent since our tip in April, 20 per cent from its peak.

A cull of senior managers, the patchy advertising market and the decline in ITV1's audience have unsettled investors, obscuring real progress in developing a multi-channel strategy, cutting costs and sprucing itself up in anticipation of a bid. We don't advise long-term holders to sell, but for our portfolio, rules is rules.

We have alighted on Xansa as a replacement, a punt on the phenomenon of "offshoring". It has long been a pioneer in the business of outsourcing, where companies hand over mundane administrative tasks to specialists who can do them more cheaply. These days, these functions might as well be done in Uttar Pradesh as in Reading, so Xansa now has as many staff in India as it does in the UK. It will move still more of its business east and the rise in profit margins ought to be the story of the next couple of years.

It is also pursuing work in the public sector and has a nascent joint venture with the National Health Service running payroll and finance functions.

Until now, Xansa has not looked cheap enough on the short-term horizon of the annual portfolio, but the stock has drifted lower. Buy.

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