The Investment Column: Slimmed-down Smiths can take off in the long term

Wolverhampton & Dudley Breweries; Micro Focus
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The Independent Online

Our view: Buy

Share price: 870p (-16.5p)

The aerospace and engineering group Smiths finally admitted yesterday that its stake in TI Automotive was probably worthless.

London-based Smiths was pressured by major shareholders to merge with TI, an American maker of car parts, in 2000.

The following year, TI was spun off and Smiths took £325m of preference shares in the hope that it would catch a rival's eye. No buyer stepped forward and no dividend was ever paid.

The decision to write down the value of the TI stake to zero, amid a weakening US auto market, cuts the sole canker from an otherwise healthy group.

Smith not only supplies components to aircraft - including the electronic nerve centre for the eagerly awaited Boeing 787 - it builds the detection devices installed at airports to keep passengers safe.

Yesterday, Smiths unveiled a 22 per cent jump in annual underlying profits before tax to £492m. That was better than the City had expected. At £3.5bn, sales were 17 per cent higher this year than last.

Sales in its aerospace business were up 13 per cent, and by 12 per cent in Smiths' detection arm. Sales at the Smiths Medical division were 31 per cent higher at £737m, bolstered by a first full-year contribution by Medex.

The group's specialty engineering division - which makes products as diverse as seals for the oil & gas industry, components for the military and naval radar - is doing nicely too.

Profits this year may have been flattered by currency conversions (more than half of Smiths' business is derived from the US), which will work against the group over the coming year, and an 8 per cent increase to the dividend to 31.35p looked a touch mean.

But the diverse group is performing well. The shares, 16.5p lower at 870p yesterday on news of the write down, are trading at about 12.7 times expected 2007 earnings and look cheap. They are a longer-term buy.

Wolverhampton & Dudley Breweries

Our view: Buy

Share price: 1,422p (-23p)

Wolverhampton & Dudley Breweries toasted a 3.7 per cent rise in like-for-like sales at its managed Pathfinder pubs yesterday.

The World Cup in Germany, coupled with scorching temperatures, delivered the expected drinking bonanza, with sales up 6.7 per cent in June and July.

The 1,898 tenanted pubs raised average profit per pub by 5 per cent in the past year. Wolves unveiled plans to open 20 new pubs in the current financial year and another 20 to 25 next year, and is moving to longer leases of 21 years, which should provide greater stability.

The acquisitive Midlands-based company has just digested Celtic Inns and Jennings. It remains on the prowl for suitable targets, at the right price, with a £400m acquisition war chest.

Like other pub groups, Wolves is grappling with rising labour costs and utility bills, with the national minimum wage rising this October. It said that soaring energy costs are adding £7m to its utility bills this year but that impact is dropping to £2.5m next year.

Wolves bought back 904,000 shares at £11.8m in August and yesterday held out the prospect of further share buy-backs.

Around 85 per cent of its pubs have gardens or patios, leaving the company better placed than most to weather next summer's nationwide smoking ban. The shares have been solid performers over the past 12 months and should not disappoint in the future. They are a buy.

Micro Focus

Our view: Sell

Share price: 116p (+5.5p)

Micro Focus shares shot up 5 per cent to 116p yesterday after the software company said it expects to achieve modest revenue growth in the first half, fuelling hopes that it has turned the corner.

Micro Focus also said its cost reduction plans have been successfully implemented. Cazenove and UBS said the comments could drive upgrades to market forecasts heading into 2007.

Yet Micro Focus has something of a chequered past. The company develops systems aimed at exploiting customers' existing IT investment and reducing the often-exorbitant costs of upgrading.

The company returned to the market in May 2005 after it was taken private earlier in the decade but was forced to slash the price range as investors exercised caution. That doubt proved to be justified. Four months after the listing, shares tumbled over 40 per cent as the company warned on revenue. Earlier this year another profit warning cost Tony Hill, the chief executive, his job.

The company's credibility has been somewhat restored by new CEO Stephen Kelly and decent full-year results in July.

Should the worst days indeed be past, a valuation of less than 13 times projected earnings for 2007 appears cheap compared with peers. Yet the discount is justified given the historic turbulence associated with the stock and taking profit now could avoid nasty shocks later. Sell the shares.

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