Don't bank on outperformance at RBS

Wolverhampton and Dudley; Avis Europe
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The Independent Online

Waiting for Royal Bank of Scotland to slip up is a bit like waiting for the property market to collapse. Bouts of weakness in the share price are usually short-lived, and before long its up, up and away again.

But RBS has recently suffered a prolonged period of outperformance amid fears that the UK's number two bank would be a major casualty from the recent collapse of the US energy trader Enron. RBS is among a handful of banks with chunky US corporate loan portfolios, and a lengthy silence over its exposure to Enron has seen the stock decline 11 per cent over the last six weeks.

A long-awaited trading statement yesterday provided the reassurance the market had needed. True, provisions against bad debts were being hiked by more than the company expected, due to "certain specific company situations" – doubtless a reference to Enron and the troubled cable company NTL. But overall credit quality was strong. Income growth in the second half was set to meet expectations and exceed the 14 per cent rise achieved in the first half. Meanwhile, the integration of NatWest has continued apace, contributing to an improvement in RBS's keenly watched cost to income ratio.

The statement left Commerzbank reiterating its forecasts for underlying pre-tax profits of £5.7bn this year, with earnings per share of 127p, rising to £6.7bn and 145p in 2002. RBS shares closed up 4.6 per cent at 1,617p.

While the company, led by the chief executive, Fred Goodwin, has no shortage of fans in the City, the outlook for its share price is varied. If the US economy fails to recover as expected next year, worries over bad debts could dampen the upward momentum. Yet if there is a strong economic upswing, investors may prefer to shift their money out of the banking sector altogether and into growth stocks. RBS, of course, is delivering cracking growth itself. All the same, it is easier to see RBS underperforming than outperforming over the next 12 months.

Wolverhampton and Dudley

Wolverhampton and Dudley Breweries knows a thing or two about problem management.

The Midlands-based brewer spent much of the year fighting tooth and nail to retain its independence in one of the City's longest ever takeover battles. Hence Wolves's speedy reaction to its latest problem, prompted – believe it or not – by a recent spike in the share price.

Rather than buying £100m of shares back at 491p a pop, Wolves will pay shareholders an 80p-a-share special dividend, accompanied by a 15 per cent share consolidation, and repurchase £24m of its stock separately. Thus the brewer fulfils the key plank of its defence against predator Pubmaster – returning value to shareholders – and the stock remains supported, above the 513p bid offer. Neat.

The defence certainly spurred Wolves into fine-tuning its business. It pared the pub estate down to 550 managed and just over 1,000 tenanted outlets and rationalised its brewing operations to two breweries at Wolverhampton and Burton. The moves leave the company poised to plough all its attention to its two main brands: Banks's and Pedigree. However, the jury is still out on whether the brewer's plans to revamp its managed pubs as "Bostin' Locals" (literally Black Country slang for "bloody good" boozers) will be worth the investment.

While full-year profits announced last month were bang in line with promises made in Wolves's defence document, the real test will come with the next set of numbers. There is little scope for dramatic organic growth and a limit to how much margins can be squeezed by merely stripping out low margin contract brewing.

The shares, up 6p yesterday to 552.5p, trade on a forward p/e ratio of about 8.5 times. That is still at a substantial discount to Wolves's arch rival, Greene King, which trades on a multiple of 11. Until Wolves's management proves it has a real growth story on its hands the stock is a hold.

Avis Europe

It is not surprising that shares in Avis Europe, the car rental group, have been kangarooing around like a bad learner driver in the past few months. Avis was hit hard by the events of 11 September, which forced the company to issue a profits warning 10 days later. But like many travel-related stocks it has been recovering sharply in recent weeks.

Yesterday's trading update didn't add that much new information but it didn't frighten the market either and the shares were duly marked up another 9.5p to 162p. That is quite a jump from their Autumn low of 103p. The question is how much is left in the tank?

Yesterday's key message was that Avis has been less affected by the terrorist attacks than might have been expected. While corporate business has been affected, particularly transatlantic custom, Avis' relatively broad spread of operation has protected it from the worst of the downturn. About half its sales comes from city, rail and resort locations where demand has been more robust.

The overall effect has been that revenues have fallen 5 per cent below the previous year, since 11 September. These trends are expected to continue into the first quarter of next year. Avis was stressing again that it has reduced its fleet (by 10 per cent) and its staffing levels too. The result is that margins should be back to normal levels by the end of this month.

On concensus profit forecasts of £88m this year and £93m next, the shares trade on a forward p/e of 14 falling to 13. An interesting recovery play given the exposure to aviation services. But it is not without risk and the big bounce in the last two months means it may be too late.