The Investment Column: Severn Trent still has potential growth left in the pipeline

Daniel Stewart; Charteris
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Our view: Buy

Share price: 1,364p (+1p)

Water companies, historically as calm as a reservoir on a lazy summer's afternoon, are now hot property.

The sector is disappearing faster than hosepipes in the South-east as hungry infrastructure specialists chase steady predictable returns backed by assets.

Earlier this week AWG, formerly Anglian Water, recommended a £2.2bn takeover offer from the private equity group 3i and a group of overseas pensions funds. Others are thought to be interested in counter-bidding.

That same day, Macquarie sold South East Water to another Australian bank, Westpac, for £665m to free itself up for a tilt at Thames Water for an estimated £7bn. MacBank faces stiff competition from three rival bidders.

Predictably, shares in the other UK water companies have surged higher on the wave of bid activity in the sector. Among them, Severn Trent continues to look likely to catch a predator's eye.

On Monday, the demerger of its Biffa waste management business will deliver the vanilla water company a yield of almost 4 per cent.

The water company itself is ticking along nicely. Led by chief executive Colin Matthews, Birmingham-based Severn Trent yesterday reassured investors that trading had been as expected in the six months to the end of September.

Including inflation, sale prices have risen 6.58 per cent from the start of April.

Interim profits before tax will be pared by £3.2m, and in the full-year by £6.3m, after the water regulator Ofwat levied penalties on the company for misleading customers

In March, Severn Trent was criticised for supplying the regulator information that was either "deliberately miscalculated or poorly supported", leading to higher- than-necessary price limits being set. That would have led to customers paying £42m more by 2010.

Severn Trent shares were chased to a fresh high earlier this week on hopes of a bid. Having traded at a "conglomerate discount", analysts at Merrill Lynch expect them to rise still higher and await interest from predators. They may look pricey, but Severn Trent shares are still a buy.

Daniel Stewart

Our view: Buy

Share price: 14.75p (-1.25p)

The boutique corporate broker Daniel Stewart Securities became the latest casualty of the US government's prohibition of internet gaming yesterday. Having helped a number of smaller online gambling companies to market, the broker was left sitting on a decent slug of shares in the sector - valued at around £1.6m at the company's year-end in March.

By the end of Monday, when share prices across the sector collapsed on the back of the news from the US, Daniel Stewart's gaming portfolio was worth some £1.3m less. The news took the shine off an amazing first half, during which the group doubled the amount of money raised and continued to grow its lucrative client-base of AIM companies. However, investors should not be too despondent.

The group's management stressed yesterday it had no other exposure to the gaming sector, reassuring shareholders that although its £1.3m loss would push the company into the red, it was a one-off event which will not be repeated. Meanwhile, the growing international acceptance of AIM - which is now firmly established as the UK's second market - ensures that prospects for the future are looking strong.

Although, in the short-term, the group's share price will fluctuate alongside sentiment towards the equity markets, longer-term the company's fundamentals look good. Trading on a multiple of just 8.5 times last year's earnings, it looks cheap compared to its peers. Given that there is still the possibility of further consolidation in the sector, the shares look certain to go higher in the medium-term. Buy.


Our view: Sell

Share price: 14.75p (-1.25p)

Charteris is a software consultant struggling to find a coherent growth strategy. The small-fry AIM stock has suffered as larger competitors have undercut it on price on its traditional consulting work. It has had to invest in building some expertise as it has found it lacks a key selling point to offset price competition - but has not been able to do this fast enough. It recorded a 10 per cent drop in sales in the second half as it failed to win the new business it needs to offset the impact of lost and maturing contracts. Over the second half, its earnings margin almost halved to 3.3 per cent.

Charteris expects revenue in 2007 to be lower than the £20.1m achieved in 2006, and cost-cutting measures will not feed through to its results in the short term. The house-broker Bridgewell Securities cut its earnings-per- share forecast to 0.4p from 1.6p on the back of the warning.

Charteris is focused on building expertise in three core areas including establishing a business to resell Microsoft's Navision products. Yet the firm has few customers in this business. It trades on less than 0.3 times sales - a bargain basement price. Yet given the work needed to build expertise and compete with its larger competitors, it is best to steer well clear for now.