Blue Chip: These chips still taste good

Johnson Matthey has plotted a course into the heart of the booming semiconductor market
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The Independent Online
Johnson Matthey is remembered by old hands for its infamous banking division that went spectacularly bust in 1984, and was subsequently rescued by the Bank of England.

Although that catastrophe is no more than City folklore nowadays, those events set in motion a change of direction that has left many puzzling about its final destination - until recently. Evidence that the group, under chairman and chief executive David Davies, is nearer to reaching the end of its journey came in its preliminary figures earlier this month.

There Mr Davies spelt out a direction for Matthey: electronics and ceramics would be the backbone of future growth, with catalytic converters for car exhausts and precious metals providing the cash.

Whether City investors remain as keen on the shares, however, is debatable. Last week, Minorco, the South African-owned natural resources group, sold its near-10 per cent stake in the group for pounds 132m. The deal, arranged by SBC Warburg, was not away as quickly as one would expect of a share in demand - especially given that it is a fairly illiquid stock. It may suggest lingering doubts about the strategy or disenchantment over the premium rating of the shares.

Either way, the key to its future lies with its decision to rely on the fortunes of the international semiconductor market. Computer chips may have suffered from a slump in prices, following a supply glut. But Matthey has steered a middle course that depends on continued growth in the demand for chips, but which it hopes will avoid commodity-style fluctuations in chip prices. Semiconductor demand is set to grow rapidly, between 15 and 20 per cent, until the next century.

Matthey's big move came last year when it paid $170m (pounds 109m) for ACI, a maker of multilayered printed circuit boards (PCBs). The deal was funded by a pounds 117m rights issue - its first for 10 years. ACI is the third largest supplier of PCBs in the US, but the spice is in its subsidiary, Acsist, which makes plastic laminate packages for semiconductors. These are simply the protective package in which the semiconductor itself is set. The total market for plastic laminate packages is worth barely $200m, but it is growing at the phenomenal rate of 100 per cent a year. The packages are traditionally made from ceramics, and it is a further measure of Matthey's scope that this area of the ceramics market is worth $2bn.

More ammunition for its assault on the semiconductor market came in March, when it paid $40m for the PCB manufacturing business of Cray Research - the world's leading designer of supercomputers. Matthey says the deal gives it instant revenues from Cray, which has agreed to buy its PCBs from Matthey. Yearly sales to the electronics industry are now more than pounds 330m - up from pounds 258m in 1995, and an insignificant amount a few years ago.

It has also told the City it expects to boost volumes at Cray from 2,000 units a week to 1 million units a week by March of next year. Although sales will rocket if these figures come true, the rise in profits will be tempered by higher costs to support the growth. Finally, Matthey has a head start on the opposition; there is no US-based competitor to Cray operating in the market.

In its other divisions, growth will be steadier, if less spectacular. Catalytic converters, an offshoot of its traditional platinum group metals business, and a market Matthey pioneered, suffered last year after General Motors, its largest customer, cancelled a sizeable contract. Profits of the division fell 24 per cent to pounds 26.2m. But R&D into new applications for catalytic converters looks set to pay off, with clean-up devices now on sale for diesel engines.

Elsewhere, a ceramics joint-venture with Cookson has also been on a roll. Operating profits rose 54 per cent to pounds 23.8m - helped by cost cuts and strong Far Eastern demand for tiles.

The puzzle is how much the share rating - which is on a fairly demanding prospective p/e of 17 times next year's earnings - reflects hopes, and how much is realistic. The group has enjoyed strong earnings growth over the past five years. From pounds 66m in 1991, pre-tax profits hit pounds 102m this year - albeit, only a 6 per cent rise on 1995.

The shares have enjoyed a strong performance over the past five years. But with the prospects for ACI and the PCB businesses, it would seem churlish to leave the convoy just as things are getting exciting. Trust Mr Davies and his management to keep the group firing on all cylinders, and buy the shares.

Johnson Matthey

Share price 629p

Prospective p/e* 17.4*

Gross dividend yield 3%

Year to 31 Dec 1994 1995 1996 1997* 1998*

Sales (pounds bn) 1.955 2.177 2.530 2.685 2.815

Pre-tax profits (pounds m) 65.3 95.4 102.2 118.3 137.8

Earnings p/share 23.5p 33.4p 34.4p 37.3p 42.9p

Dividend 11.4p 13.5p 14.5p 16p 17.5p

* NatWest Securities forecasts