Apocalypse now for Gas shareholders
The Investment Column
Friday 17 May 1996
The gamble was always that Ofgas regulator Clare Spottiswoode would be more lenient than expected in her review of the future regulation of TransCo International, the pipeline business to be demerged next year.
As it happened, instead of the expected pounds 300m cut in revenues, her initial thoughts unveiled earlier this week point to the new company's pounds 3bn sales being slashed by as much as pounds 850m. The dividend is now clearly in doubt and the shares have crashed by 53.5p to 174.5p over the past week alone, after a further 14p fall yesterday.
Even without the intervention of the regulator, British Gas is already being savaged by the onset of competition. This year's first quarter should have been boosted by the return of a traditional cold winter. Sure enough, profits for the three months to March, revealed yesterday, got a weather- related lift worth around pounds 150m compared with the same period of 1995, but competition in its various forms still conspired to more than wipe that out. Operating profits just crept ahead by pounds 1m to pounds 969m, but interest charges doubled to pounds 60m cut the pre-tax total from pounds 954m to pounds 933m.
BG's trading arm, the "customer facing" parts of the business, bore the brunt of the attack from competitors. The maintenance of the regulatory requirement that it publish price schedules until the middle of 1995 meant the group's customers were easy to pick off by rivals and BG's share of the commercial and industrial market has accordingly sunk from around 55 per cent to 35 per cent.
The slump has been stabilised, but at some cost to margins. Operating profits from the trading business slumped from pounds 187m to pounds 121m in the latest period, while turnover was broadly static at pounds 2.9bn.
That, however, is only a foretaste of things to come. The high-priced North Sea gas contracts, typically at around 19p a therm, which are being inherited by the trading business, put it on course to lose around pounds 400m this year, given that the current spot price of gas is nearer 10p a therm.
These take-or-pay contracts forced the group to fork out around pounds 500m for gas it did not buy last year and could mean another pounds 300m payment in 1996. With restructuring costs this year and last adding another pounds 1bn or more to cash outflow, it is little surprise that gearing has risen from 10 per cent to 17 per cent in the 12 months to March. These problems are bad enough, but it is the apocalyptic scenario opened up by Ms Spottiswood's proposals that will drive the share price in the short term. A Monopolies and Mergers Commission reference may not bring much relief to British Gas, so the prospect of a 50 per cent dividend cut looms. That would suggest a yield of over 5 per cent at the current share price, which must give it some sort of floor. One only for the brave.
offers little fizz
For a company that has developed an unfortunate reputation for large-scale provisions, continually re-stated figures and Byzantine accounting, Grand Metropolitan is threatening to become almost conservative.
Yesterday's interim results included only pounds 6m of exceptionals and were the second set of figures in a row that did not re-state those of the previous year.
There is even talk of a possible share buy-back to increase shareholder value, replacing the acquisition-fuelled stategy that was such a feature of the Lord Sheppard years.
The reshaping of the portfolio that started under Lord Sheppard, who stepped down as chairman in March, is poised to continue.
Yesterday, Grand Met announced that the underperforming Pearle opticians business will be sold, although Burger King is staying put in spite of persistent speculation that it too will be off-loaded.
But for all the group's re-shaping, Grand Met shares have still underperformed the rest of the market by 27 per cent over the past five years and yesterday's results showed that the job is only half done.
Pre-exceptional profits for the six months to the end of March edged up just 3.2 per cent to pounds 455m, with much of the growth due to the performance of the Pillsbury food business in the United States.
Pillsbury's operating profits grew by 47 per cent, helped by a full six months' contribution from last year's Pet acquisition.
Profits at the IDV drinks business were flat at pounds 211m but this is a better performance than rivals such as the struggling Allied Domecq. Price increases of 1.5 per cent have been pushed though with volumes up by 5 per cent.
Burger King is doing well in America, which accounts for 80 per cent of its sales, but the performance in Europe is more patchy. The UK recorded a loss and sales have fallen by 11 per cent since the end of March due to the BSE scare over beef.
Grand Met shares have been treading water recently and fell a further 6p yesterday to 440p.
Given the difficulties in the drinks market, the outlook remains dull. On analysts' full-year profit forecasts of pounds 970m, the shares are on a forward rating of 14. Unexciting.
Compass, the contract caterer where Granada chief Gerry Robinson earned his spurs, has moved quickly to establish itself as one of the big players in its field. The finishing touches are being put to a two- year acquisition binge that has seen Compass pay pounds 310m for Canteen in the US and pounds 589m for a 33 per cent stake in Eurest of France.
According to chief executive Francis McKay, only a "few legal hoops" stand in the way of it acquiring a controlling stake in Eurest after the company's managers last month voted to sell their 33 per cent shareholding for pounds 83m. The legal technicalities relate to rival caterer Sodexho, which was involved in separate talks to buy Eurest.
Assuming the Eurest deal goes ahead, Compass will command the number three positions in the US and France, joint first position in the UK and, most significantly, market leadership in Germany, Europe's biggest catering market.
The task now is to drive margins up to generate the double-digit earnings growth that would justify the group's premium rating on the stock market. Yesterday's half-year figures were a mixed bag on this score. Stripping out the pounds 20m exceptional gain on the sale of the health-care division, pre-tax profits rose to pounds 47.8m from pounds 31m. Margins in the US rose, were flat in the UK and fell in Scandinavia. No figures were available for the rest of Europe.
Great opportunities exist in Germany, where recession-hit companies increasingly focus on non-core areas such as catering to outsource and save costs. That should provide a good long-term opportunity. But with debts of pounds 305m and negative shareholders' funds, it looks very exposed if interest rates start rising again.
BZW is looking for full-year underlying pre-tax profits of pounds 114m this year, putting the shares, down 7p at 528p, on a multiple of 20. High enough.
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