BP faces a fight to stay healthy

THE INVESTMENT COLUMN
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Over the past three years British Petroleum has climbed extremely effectively out of the deep hole it had previously dug itself into. Britain's flagship oil group was looking decidedly dishevelled in the early part of the decade after a massive buying spree left it saddled with debt.

Since then the group has lost a chief executive, disposed of several large peripheral businesses and taken a huge slice out of its costs. The results have cascaded through to the bottom line and BP yesterday set the final seal on its recovery when it announced a fourth- quarterly dividend raised 6 per cent to 4.25p, taking it through the level from which it was halved in 1992.

But the problems facing the oil group are in many ways much harder than those it faced four years ago. The underlying picture displayed by yesterday's record replacement-cost operating results - excluding distortions like exceptional write-offs and stock gains - is of rude health. Profits soared from pounds 1.48bn in 1994 to pounds 2.01bn in the 12 months to December. With replacement- cost earnings per share up over a third to 36.3p, it is hardly surprising that BP feels able to lift its 1995 total dividend by 45 per cent.

The conundrum is how to maintain this momentum when most of the obvious cost-cutting and debt reduction measures have been completed and the main markets are moving the wrong way. The most extreme example is in chemicals, where operating profits last year more than trebled to pounds 854m, the best ever. But the peak in the cycle is long gone. Fourth-quarter chemicals profits slumped 44 per cent from the previous three months and although there are signs of the slide bottoming out, BP does not expect much evidence of recovery before the second half.

Meanwhile, the downstream business continues to be bloody, with refining margins at a 10-year low and price wars in petrol retailing breaking out in the UK and Australia. BP's action to trim its refinery base, at a cost of pounds 965m in these figures, is commendable, but the rest of the industry seems wedded to over-capacity and the outlook for margins is for more of the same.

BP has also done a good job in the upstream business which dominates the group. It now replaces more oil than it produces, but its main weakness - that production is geographically highly concentrated - remains. That continues to make it a less defensive group than the likes of Shell and, with Iraq apparently poised to re-enter the market, the oil price may remain weak. Historic profits of pounds 2.3bn this year would put the shares, down 8.5p at 536.5p, on a prospective multiple of 13. Hold only for the prospective yield of 4.2 per cent.

Reuters just runs and runs

One of the biggest challenges facing investors is not picking the right stocks in the first place but, having picked them, maintaining the courage to stick with the winners and get the most out of a strong run.

Six months ago, given a deceptively gloomy nod by the company, most commentators (ourselves included) were recommending taking profits on Reuters. After yesterday's 26p rise to 670p they will regret their fickleness.

Since Peter Job stood up in New York last July and warned that double- digit sales growth was a thing of the past, the shares, after an initial bout of weakness, have risen 27 per cent, outperforming a buoyant stock market by 17 per cent along the way.

One of the driving forces behind the share price is the widely held view that Reuters will have to stage another share buy-back to reduce the embarrassing cash pile that last year increased by pounds 316m to pounds 850m. Analysts believe it could hand pounds 500m of that back to shareholders, reducing the share capital by about 5 per cent.

That is one good reason Reuters was confident enough yesterday to forecast double-digit earnings growth, even if it couldn't quite manage that sort of increase at the sales line. Analysts were increasing forecasts for this year and next to reflect better-than-expected growth in sales of transaction products such as Instinet and Dealing 2000. That made up for the predicted decline in information products.

Taking a longer-term view is the key to investing in Reuters, an important counter-balance to short-term worries about this or that product. It will remind you, for example, that Reuters has been churning out a return on equity of more than 40 per cent for over a decade (currently it is more than 50 per cent). Since 1984, the dividend per share has risen from 0.63p to this year's 9.8p and cash flow per share is up from 6.1p to 52.7p.

With forecasts pushed up to pounds 680m for 1996, followed by pounds 750m next year, the shares stand on a prospective p/e ratio in the low twenties. That looks demanding, but so it has for years - it doesn't stop the shares' relentless rise.

Argyll suffers in price cutting

The share-price reaction to yesterday's trading statement from Argyll was rather perverse. The Safeway supermarket group said like-for- like sales were up by 8.3 per cent during the 17 weeks to 10 February which is as good as Tesco's recent figures and a good deal better than Sainsbury's. The figures may have been slightly disappointing but were hardly disastrous.

The 5p drop in the shares to 315p owed more to the downbeat message on margins. Safeway has been driving sales with its ABC loyalty card, a series of price promotions and its popular "Harry" advertising campaign, which have all had a negative effect on returns. Argyll's comment that gross margins were "a little below" last year's put the frighteners on some in the City even though the company said as much at the half year and made assurances yesterday that the situation was improving. Argyll yesterday announced a move into childrenswear which has proved a strong market for Tesco, Asda and Sainsbury's SavaCentres.

But whenever the going gets tough in the supermarket sector, it gets toughest for Argyll. It is fourth in the market behind Tesco, Sainsbury and Asda and, rightly or wrongly, it is perceived as less able to withstand a nasty battle.

That battle has been intensifying in recent weeks with a spate of price promotions which has seen the price of a can of baked beans fall to as low as 8p. On top of this, Esso has put the pressure on with its Pricewatch initiative and half of Safeway's margin decline was due to petrol.

Analysts are forecasting pre-tax profits of pounds 403m for Argyll's full year which puts the shares on a forward rating of 13. But the prospect of a further bout of price cuts is still casting a cloud over the entire sector. Argyll may be one of the cheaper stocks but until that uncertainty clears away, the shares rank as no more than a hold.

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