Behind Zeneca's glamour rating

THE INVESTMENT COLUMN

Zeneca has been the object of so much takeover speculation recently that nobody seemed terribly interested in interim figures yesterday from the former ICI drugs arm. That is a mistake, because if the company's robust rebuttal of bid talk is to be believed, the market will have to start valuing Zeneca on fundamentals once more.

The bid story is unlikely to go away as long as the drugs industry continues to consolidate at its current rapid rate. Zeneca is plainly still attractive, if expensive, and Roche, the rumoured predator, is perhaps the only company with the firepower and the acquisition history to be a serious contender.

But pounds 15bn, which is what it would probably have to pay to secure control of Zeneca, would be a massive undertaking even for Roche. It would be paying a pharmaceutical multiple for a big chunk of much lower-margin agrochemical and speciality chemical earnings. Perhaps most importantly, David Barnes, chief executive, has made things quite clear - Zeneca and Roche are not talking.

How then do Zeneca's figures and its relatively fancy rating stack up together? Yesterday's half-time profits, up 44 per cent to pounds 506m, were flattered by last year's pounds 100m exceptional charge, but even on a comparable basis, there was a 12 per cent improvement. Earnings per share, up 41 per cent to 35.8p, allowed a 0.5p rise in the dividend to 11.25p.

Zeneca's return on sales, at 20.4 per cent was a record, as were sales from the core drugs arm, which breached pounds 1bn for the first time in a six- month period. The underlying business is as strong as ever despite cautious hints about second-half margins, expected to be squeezed by the costs of promoting new treatments. Analysts describe Zeneca as the sector's lowest-risk business.

That reflects its solid new drugs pipeline, which includes four new treatments for cancer, an innovative pill for asthma and a schizophrenia drug. It is also an appreciation of the recent Salick acquisition, which took Zeneca into managed cancer care for the first time.

Salick owns specialised cancer clinics in the US and represents the future of health care in America and, probably, Europe as well. Giving Zeneca exposure to the growing market for cancer treatment, even without new drugs, it is a sensible diversification and, on the basis of a 50 per cent initial stake, a relatively low-risk venture.

Profits are forecast to grow from an underlying pounds 797m last year to pounds 860m this time and pounds 960m in 1996. That puts the shares, down 23p to 1,097p yesterday, on a prospective price-earnings ratio, 18 months out, of 16. On a sizeable premium to Glaxo's 13.5 times multiple and a slightly better rating even than US stocks in the sector, the shares still appear to reflect a bit of bid froth. While a takeover remains an outside chance they probably won't fall far, but equally the upside looks limited.

Time for Shell to grit its teeth

Shares in Shell were suffering yesterday from the problem all cyclical companies face once the market sees confirmation of an earnings plateau ahead. Results may be impressive but the City always looks forward and the 15p fall to 759p reflected its concerns.

Interim results were exceptionally buoyant, with net income in the second quarter up 90 per cent to pounds 1.28bn. Admittedly, the number was flattered by an pounds 80m special credit from sale of copper interests in Chile and a pounds 77m currency gain. But chemicals continued their much-improved performance, making a pounds 313m profit instead of a pounds 41m loss a year earlier.

The comparison is with the last of the bad quarters before the recovery began, and the latest quarter includes consolidation for the first time of new chemical subsidiary Montell, so the underlying trend compared with the immediately preceding quarter is rather flat. But there was little to complain about, especially as firmer oil prices also boosted exploration and production profits 47 per cent.

The real difficulty was with Shell's comments on the oil market and the rather gloomier than expected forecast for chemicals, the heart of Shell's recovery over the past year.

Oil prices remained strong until April but fell sharply at the end of the second quarter, with Brent now trading at about $16 a barrel and expected to stay around that level for the current quarter.

Ignoring minor shades of opinion, there was little here that was not built into the market's expectations. But one problem will continue to undermine Shell's shares relative to the rest of the oil sector.

Shell trades at a 10 per cent premium to the market. BP, which has much better dividend growth prospects because it starts from a lower point, trades marginally below. The whole sector is at risk from weaker oil and chemical markets over the next couple of years, and Shell more so than its peers.

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