Outlook: Abbey still struggling to turn itself around

Housing uncertainty; Brunswick
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The Independent Online

Abbey National is turning out to be more of a long-haul, J Sainsbury-type turnaround than the short hop back to former glories the City had hoped for. To be fair on Luqman Arnold, the chief executive, he'd never pretended otherwise, repeatedly stressing that it would take at least three years for the magic to work. Yet one year in, and the red ink is still flowing freely and the underlying business seems to be in a state of continued deterioration.

Yesterday's "surprise" was that the company has had to put aside an extra £373m to meet stringent new FSA solvency requirements in its life business. Abbey freely admits that it has no idea whether it will be enough, but in any case the move is bound to limit Abbey's ability to pay a half-promised special dividend from the proceeds of asset disposals. The shares duly bombed 12 per cent, wiping out much of the "recovery stock" status that has marked Abbey out from the pack this past year.

Rather like Sir Peter Davis at J Sainsbury, Mr Arnold points to the fact that the company was almost beyond redemption at the time he was parachuted in. The ship had been holed below the water line by a disastrous expansion into wholesale, commercial banking, and the core retail banking brand, once the envy of high street rivals, was in a state of near terminal decline, the inevitable consequence of years of management neglect and underinvestment.

The salvage effort alone has been hard enough, Mr Arnold protests; there are no quick solutions in the yet more difficult task of restoring the business to operational health. Yet the City was plainly hoping for more, and reasonably so in some respects. The underlying picture is one of a company that's continuing to take on water. For instance, total retail deposit inflows fell £700m last year to £1.2bn, reducing Abbey's share of total household deposit flows from 2.2 per cent to 1.6 per cent. That's bound to affect Abbey's ability to grow its mortgage book, where the position is equally disturbing.

Here Abbey is being forced to fix another of its historic problems ­ that the variable-rate mortgage products that dominate the back book were more highly priced than competitors'. As a result, the average margin between what the bank lends at and what it borrows at shrank last year to just 1.74 percentage points, one of the lowest in the business. Abbey has achieved some success in clawing back market share in new mortgage business over the past year, but only at a considerable cost to margins, and you have to wonder how much of that new business will hang around long enough to become profitable. Again worryingly, Abbey's ability to cross sell more immediately profitable products such as general insurance seems to have slipped yet further behind rivals. Only 218,000 building and contents policies were sold last year, against 267,000 the year before.

Thankfully, Mr Arnold is not asking shareholders to wait until the end of his three-year turnaround strategy to see at least some of its fruits. The target is for the second half this year to show a real improvement in revenues over the first half. If that doesn't happen, then questions will rightly be asked. Yet somehow or other, Mr Arnold has to make the turnaround work, for there's unlikely to be anyone out there willing to put Abbey out of its misery with a reasonably priced bid.

Those who can afford it, such as Royal Bank of Scotland's Fred Goodwin, would almost certainly be disallowed by the competition authorities, while those who would have no such competition hurdles to surmount ­ say a big overseas bank ­ would likely find Abbey still too expensive, even at today's depressed price. If there is to be no "mercy killing", then Abbey must struggle on by itself. With the market more competitive now than it has ever been; "struggle" may be the operative word.

MFI/Housing

John Hancock has achieved a spectacular turnaround at MFI in the four years he's been chief executive, for which he has been handsomely rewarded with a share price that has risen many fold. Yet despite his achievement, the stock continues to trade at a sizeable discount to the retail sector as a whole. Yesterday gave us part of the explanation. Profits are still growing strongly; that much we don't have to worry about. Mr Hancock has made MFI's cost base so flexible that if the market turns down, then costs too can be immediately adjusted to take that into account, so that there is no damage to the bottom line. Yet MFI still has the ability to disappoint with negative news. In the period from 26 December to 24 February, normally strong for MFI, like-for-like sales fell 3 per cent.

Even allowing for greater competition from the likes of B & Q, the downturn is a definite curiosity. Another reason why MFI's shares trade at a discount to other retailers is that the company's sales are so strongly linked to the state of the housing market. As the latest house price survey from the Nationwide building society demonstrates, the housing market again seems to be defying all predictions by continuing to boom. The more people that move, the more kitchens MFI sells, yet on the evidence of these figures, it doesn't seem to be working that way.

One reason why house prices are again rising strongly may be that there is a shortage of properties coming on to the market, further compounding an already acute housing supply problem. Higher value but fewer transactions doesn't benefit MFI at all. That certainly seems to be the case in London, where prices are again rising strongly after a period of decline. The constant complaint of estate agents is that there are just not enough decent houses and flats to sell, a phenomenon partly explained by buy-to-let, which seems permanently to have reduced the turnover of housing stock.

Yet nationally, these observations are not supported by the statistics. Mortgage approvals for new house purchases are currently running at 10-year highs. The number of transactions is not falling but rising.

If there is no decent explanation for the dip in MFI's sales, we do at least know why the housing market is turning up again. Economic growth has returned with a vengeance. As job insecurity fades, prospective house purchasers feel more confident that the present balmy level of prices can indeed be sustained, and are, therefore, more willing to pay them. Rising interest rates will eventually bring the housing boom to an end, but they may have to rise quite a bit before they work.

Brunswick

Brunswick is the doyen of City public relations firms. Bigger by an order of magnitude than any of its rivals, it's the firm large companies tend to turn to first whenever they are in trouble and think they might be able to spin their way out of it. Yet despite big salaries and big bonuses, the partners have been getting fractious. Their complaint? That Alan Parker, the firm's founding father, keeps all the equity to himself. In most privately owned companies, this would not seem unreasonable. The boss is the boss because he owns the company. But in the people-based businesses that populate the City, the big-fee earners are no longer satisfied with a cut of the profits. They also want a share of the action.

In some respects, it's amazing Mr Parker has been able to hold out as long as he has. Over the years, some of his most talented practitioners have quit in frustration, knowing that if ever the company is sold, they would be unable to share in the resulting cash bonanza. Mr Parker denies that the decision to place nearly half the company's shares into a pool for the benefit of other partners was prompted by the threat of another walkout, or that it is a precursor to a sale or flotation. Yet it is hard to see it any other way. The gamble Mr Parker is making is that his holding of shares in Brunswick will be worth more if he gives some of them away than if he keeps them all to himself. Mr Parker missed his chance to sell the company at the top of the last boom. I doubt he'll make that mistake again.

jeremy.warner@independent.co.uk

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