Blue Chip: BOC shows lung power

The market leader in gas supplies must constantly invest and invent to stay ahead of its rivals

BOC - or The British Oxygen Company, as was - seems to have been working at low pressure over the past year. While the shares have picked up recently, they remain below the all-time high of 945p they hit in June.

This sluggishness was partly due to a disguised profits warning issued by the company at its nine-month figures last August. And the industrial gases group - responsible for the fizz in many beers and sparkling soft drinks - has yet to convince the stock market that it can propel growth at above average rates into the next century.

The business is a curious hybrid of high- and low-tech. It sells an increasing range of ever more specialised gases - some 20,000 mixes at the last count - but for cylinder supplies, the market is not much changed from 30 years ago. However, the company now also supplies gases direct by pipeline to large industrial plants to satisfy demands of hundreds of tonnes a day. In each case the gas is piped directly from a BOC plant, built specifically to serve the clients' needs, but with excess capacity to supply other customers.

Direct pipelines now account for 45 per cent of the gas sold by BOC. This is a highly capital-intensive business because of the need for dedicated production plants. Transportation costs mean it is only economically viable to deliver gas within a 150-mile radius of a plant.

A similar proviso applies to pressurised cylinders - the more familiar way of shipping gas. Each cylinder costs far more than the gas it contains and much of the cash flow comes from leasing the cylinders to customers, who return them on a regular basis to be refilled.

Demand for gas has excellent growth prospects, partly because of new uses in areas as diverse as electronics and chemicals. On Thursday BOC announced another breakthrough, with the launch of the first new cryogen (very cold substance) to be developed in 20 years.

Synthetic liquid air is set to become a highly versatile coolant that could open up new markets worth pounds 200m a year. The substance has a temperature of minus 191 degrees centigrade and is made by mixing liquid nitrogen and liquid oxygen. One of its advantages is that it can be breathed, whereas pure liquid oxygen or liquid nitrogen are lethal, the latter being sold by BOC to kill factory chickens.

In its other divisions - healthcare and vacuum technology - BOC has suffered reverses, although these should be temporary. The healthcare business experienced a steep decline after its anaesthetic Forane came off patent in the United States.

However, the company has two strong cards up its sleeve, although it remains to be seen if they are aces. Suprane, a replacement anaesthetic, is rapidly rebuilding the market share lost by Forane. It has also developed a patented delivery system for nitric oxide, which can be used to treat blue baby syndrome, in which the lungs of new-born and premature babies do not deliver enough oxygen to the blood.

Its Edwards Vacuum Products subsidiary has also suffered some problems, although BOC and the City are confident these are only temporary. Edwards makes vacuum pumps used in the manufacture of microchips, which need a pure atmosphere.

Recent turbulence in silicon chip demand had a knock-on effect for BOC but the division should be over the worst.

As a highly specialised business, BOC has few competitors of any significance in the UK, where it enjoys a market share of 75 per cent - more in niche segments. Nevertheless, its fortunes are closely aligned to the general health of the economy and the industrial cycle for heavy manufacturing.

Danny Rosenkranz, BOC's chief executive, has stated that BOC has a growth target 1.5 times the rate of GDP growth in the markets in which it operates. But there are areas, including the Asia Pacific rim, where it can expect far higher returns. There, growth rates of as high as 10 per cent are expected in China and other countries.

While the shares trade at a 10 per cent premium to other chemical manufacturers, they do not enjoy a rating that suggests the market is convinced of anything more than decent growth.

Mr Rosenkranz wants to improve margins, especially in the US,where competitors such as Air Products enjoy higher profits. BOC may achieve this but it will always be caught by the double-edged sword of a highly cash-generative business that, in turn, needs cash to fund a constant investment programme to meet rising demand. And inroads from competitors overseas may continue to erode the gains.

On balance, the shares will provide a safe hold. The downside is limited. And if vacuum technology and the healthcare division start firing simultaneously, BOC should be en route to far higher returns.

BOC Group

Share price 949p

Prospective p/e 15.5*

Gross dividend yield 3.8%

1994 1995 1996 1997* 1998*

Turnover (pounds m) 3,067.5 3,543.9 3,752.1 3,900 4,225

Pre-tax profits (pounds m) 253.1 402.2 444.9 445 505

Earnings p/s (p) 23.82 51.97 57.74 57.2 65.0

Dividend p/s (p) 23.2 24.8 27.0 29.0 31.0

*NatWest Securities forecasts