Northumbrian too high

Keep an interest in St Modwen; Hold off for an Alterian motive to buy
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The Independent Online

Is it worth dipping a toe in Northumbrian Water?

The water utility with interests in Northern England, Sussex and Essex floated on the junior AIM market in May but financial forecasts for the group are only now bubbling to the surface. An investment note by Deutsche Bank began circulating yesterday - it had been eagerly awaited since Deutsche organised the flotation and its forecasts are the first from a broker so close to the company. Unsurprisingly, Deutsche is recommending investors buy the shares.

Certainly they have had a warm welcome, rising from the float price of £1 to 115p at one point. Deutsche is right to argue that the main attraction of Northumbrian is the dividend, yielding more than 7 per cent. This puts it near the top of the water sector and, when the company sets out its full dividend strategy for the coming couple of years in November, it is almost certain to promise rises of at least the rate of inflation.

The problem is that the managing director, John Cuthbert, won't be able to make any promises beyond mid-2005, since the group's future profitability is entirely up in the air. This is the start of a new price regime to be imposed by the industry regulator, Ofwat. So far the omens look good, with Ofwat signalling it will allow price rises to customers to help pay for investment and dividends. But the devil will be in the detail and water shares have tended to underperform in the run-up to price reviews.

Northumbrian, while undoubtedly one of the better water companies when it comes to customer service, is also one of the most highly indebted, with debt representing 80 per cent of the value of its regulated assets. High interest payments mean less room for error and magnify the risks to shareholders of the price review or of other operational cock-ups. It means the sector-busting multiple of earnings on which the shares trade looks too high. Investors ought to forego a few pennies of dividend for greater security of a stock elsewhere in the sector.

Keep an interest in St Modwen

St Modwen properties is the kind of "activist" property company that long-term investors should prefer. Rather than simply sitting on its portfolio, harvesting the rents, it actively pursues run-down retail or industrial sites where it can use its skills to renovate and redevelop and increase their value, eventually selling them on for a tidy profit. That's nice for shareholders, who - if all goes according to the management's plan - should see a doubling of the company's asset value every five years.

The question is whether now is absolutely the right time to move in on the stock. We advised taking profits in February and, though there was a sharp fall soon after, the shares are back at those levels and edged 3.5p higher to 189.5p yesterday after robust interim results. Profit before tax in the six months to 31 May jumped 23 per cent to £17.9m. Net assets per share was 167.9p, up from 143.4p a year ago but, less impressively, only from 160.9p in the past six months.

Rental income, about half the profit, is flat as the economic downturn means tenants are not agreeing to big increases. Vacancies are flat at about 15 per cent. St Modwen says it has exacerbated the situation itself by throwing more people out in advance of big industrial renovation projects. But with the company's retail properties (45 per cent of the portfolio) going the same way as the office and industrial sector, the chances are there will be no big pick-up soon.

It is probably not yet time to pile back into the stock, but it has historically traded at a premium to net assets, and is therefore worth holding.

Hold off for an Alterian motive to buy

Alterian is a stock market tiddler which develops software that enables companies to search vast volumes of data quickly. It does not sell direct to end-users, relying instead on selling its product to "business partners" such as Experian, the financial information group. They, in turn, might target a bank which could use Alterian's programmes to search through all its customers to determine which of them would be the most appropriate targets for a new product.

Like most software companies, Alterian's share price chart looks like a particularly scary ski run, though it does have a nice upward tilt at the end as the market has improved. The business was helped through the dark times by the £35m it raised from its float in July 2000. It still has £14.7m in the bank and the business is forecast to make a maiden profit of £100,000 in the year to March 2004.

First-quarter figures show reduced losses of £1.3m, down from £1.7m a year ago. Sales dipped, though Alterian said this was because it is moving from one-off software sales to deals where revenue is split between an up-front fee and recurring annual payments.

Alterian announced in April a new deal with Experian and has signed a new agreement with infoUSA, a big American firm. This is a four-year tie-up with minimum quarterly payments of $3.5m.

So far, so good then, but the 10 per cent fall in the shares to 59p yesterday reflected profit taking after a good run. The shares are an interesting prospect but are likely to pause for breath now. There is no need to log on just yet.