Hold Rentokil in volatile times

Rexam; London Bridge  
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The Independent Online

Rentokil Initial has been in recovery mode since Sir Clive Thompson, the group's long-time chief executive formally abandoned the 20 per cent earnings growth target a couple of years ago. He claims he is pleased to have lost the "Mr 20 per cent" nickname. Instead he wants to re-invent himself as "Mr Substantially Outperform". It's a bit of a mouthful but at least he is delivering on his promise with Rentokil shares outperforming the support services sector by 90 per cent in the past year.

That has not been difficult of course as the shares were looking as dead as one of the group's exterminated rodents last September when they languished at 150p.

Yesterday they shot up 7 per cent to 248p on the back of better than expected half-year results. Profits from continuing operations rose 7.7 per cent to £206m with earnings per share up 12 per cent.

These days Rentokil is less about deals than the prosaic work of making its existing operations work better. It sold off 30 per cent of its sales last year when it got out of lower margin or cyclical businesses such as plant hire, transport and personnel. Now it is concentrating on organic growth and margin improvement in its main areas of hygiene, security, tropical plants and pest control. This appears to be working with profits up in all sectors, apart from security, and margins improving.

Meanwhile, the company has bought back £236m of its shares this year. With interest cover set to fall to four times, Rentokil says it has a £700m war chest to fund further buy-backs which are earnings enhancing at up to 300p on current year forecasts. Bolt-on acquisitions are also on the cards.

The bull case for Rentokil shares is that this business has traded well through recessions before as companies still tend to contract out essential services such as cleaning and security in tough times. Also, its exposure to the slowing US economy is relatively limited (15 per cent of sales and just 5 per cent of profits). The bear case is that the shares have already enjoyed a good run.

Analysts are forecasting full-year profits of £378m, leaving the shares to trade on a forward price-earnings ratio of 19. They look a decent hold in difficult markets.

Rexam

Investors had two chances to get into Rexam, the former Bowater conglomerate that is now focused on consumer packaging, during the dot.com boom. Since the last opportunity in the winter of 2000, when the shares came unstuck and sunk near to their 1998 lows, the stock has doubled.

Yesterday, the company reported an 11 per cent rise in interim pre-tax profit to £103m. Total sales, fuelled by the £1.5bn acquisition of American National Can a year ago, soared by nearly two-thirds to £1.8bn.

That deal turned the corner on a five-year selling spree which saw Rolf Borjesson, the chief executive, shed more than 100 businesses. Rexam still has three units displaying 'for sale' signs but expects all but the imaging plant operation to be sold by the year-end.

At that point, Mr Borjesson says net debt will be around £1.4bn. That will put the ratio of cash flow to interest costs at well over three, thus leaving room for some modest in-fill acquisitions.

Here the target will be plastic packaging. Rexam is already the largest drinks container maker in the world, making 45 billion cans a year, which is good for around a 20 per cent share of the global market. In plastic packaging, the company sees the opportunity to build a second leg for the business.

Bulls cite Rexam's non-cyclical, cash generative characteristics. They also point up the steady, if modest, growth of its everyday products. Bears fear higher materials costs, but concede that that isn't going to be a factor anytime soon.

Up 9.5p to 350.5p yesterday, Rexam is trading on a prospective p/e ratio of just more than 10 times forecast full-year earnings of £215m. That low rating combined with a 4.5 per cent yield should propel further progress. Buy.

London Bridge

London Bridge may no longer be falling but it is hard to know when growth will return to its core debt collection software and consultancy markets. But after joining the ignominious 90 per cent club LBS could be at a bottom.

Yesterday it reported a decline in interim pre-tax profit to £5.5m from £5.7m a year ago, while sales totalled £37m. Though the group suffers from having most of its sales in the slumping US market, the tough business outlook stateside has steadied demand from utilities and credit card businesses for the firm's collection software.

With full-year earnings per share forecast at 5.7p, the stock, up 10p at 106p, now trades on a sensible p/e of 19. Worth watching.

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