Time to bank profits from Gallaher

Gallaher; Davis Service; Screen
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The Independent Online

Since picking up the reins at Gallaher at the start of 2000, Nigel Northridge, the chief executive, has made up for years spent making do with the mature UK market. Banking on the eastern European fondness for a fag, he has dug deep and added Austria Tabak to Gallaher's purchase last year of Russia's Liggett-Ducat.

The aim? To nearly double the proportion of overseas earnings to 50 per cent over the next couple of years.

Gallaher had no option if it was to compensate for a declining UK market in which its brands, like Benson & Hedges and Silk Cut, have just lost leadership. Worse still, in March, Gordon Brown, the Chancellor, ended the practice of "unrestricted forestalling" – letting ciggie companies pay duty on stock just before a Budget increase, then selling it at post-Budget prices.

Question marks still overshadow Mr Northridge's expansion aims. Investors remain wary of the unstable business climate in Russia and the rest of the former Soviet states. News yesterday that Gallaher was looking to start manufacturing cigarettes in Ukraine worried the market.

The City is also nervous over Austria Tabak. Gallaher must fight to retain the right to AT's licensed brands, which are subject to a change of control clause and comprise some 40 per cent of turnover.

Gallaher yesterday reported interim pre-tax profit up 11.5 per cent to £173m on gross sales up 5 per cent at £2.3bn, narrowly beating expectations. While 20 per cent organic growth in its international operations was encouraging, Gallaher has more to do.

Analysts are forecasting full-year pre-tax profit of £361m and earnings per share of 42.8p. That puts the shares, falling by 9.25p yesterday to 380.75p, on a forward price/earning ratio of about 11 times. That is historically expensive, and the storming run for defensive stocks is unlikely to last when corporate profits begin to recover from the economic slowdown. Gallaher shareholders should bank their recent profits.

Davis Service

The German broker Dresdner Kleinwort Wasserstein – who, according to a misspelt note yesterday, is "grocer and financial adviser to Davis Service" – headed an impressive list of banks pushing the support services group's shares after Davis produced some stonking half-year figures against all the odds.

Davis Service hires out tools to small businesses, hires out overalls, and provides prefabricated buildings. Mundane businesses, perhaps, but the group squeezed 16 per cent profit growth out of them despite foot-and-mouth affecting uniform hire to the tourism industry and the manufacturing recession hitting its industrial clothing business. Pre-tax profits were £29.7m on sales of £245.6m in the first half.

Its £33m acquisition of RentX tool hire chain in the US, completed only in July, should keep the momentum going. RentX had been run as a rag-bag of autonomus businesses, and there will be benefits from standardising prices and trading practices under Davis's HSS brand.

The existence of the pre-fab buildings business has meant the market has valued the stock as a construction stock, rather than the more highly-rated support services sector. The division will probably be first for the chop if the dynamic management team want to raise cash to expand the textile business in Europe.

The shares have gone up a by a third in the past year, and DKW forecasts £71.1m profit in the full-year and double-digit earnings growth for the next three years. With trading going swimmingly, and management looking actively for big deals, its forward p/e of 11 is too small. Up 18.5p to 391p yesterday, the stock has some way still to go.


Screen, one of the most hyped and widely-bought technology stocks of the New Economy bubble, produced interim figures yesterday that showed sales of its portfolio of CCTV and mobile computer products more than doubled over last year. Pre-tax losses halved to just £95,000. Time, then, to believe the hype again?

The trouble with the results yesterday was that it was impossible to separate underlying growth from the effect of the myriad acquisitions that Screen has made in the last 18 months. The company said only that there was growth from all divisions except Petards Mobile, which provides police cars with dashboard computers that can, among other hi-tech skills, read the number plates of the vehicle in front.

The division is introducing a new hand-held product, and police forces have understandably held back on purchasing new equipment until its launch. The risk now, though, is that the new product won't generate the revenue required to make its house broker's full-year numbers. That would be a significant setback, since the marketing and technical effort that has gone into the launch cannot quickly be scaled back.

Screen has made progress extending its product range and marketing reach through giant acquisitions such as the civil IT systems division of BAe Systems. But the likelihood is, at least for the time being, that technology shares will continue to be shunned by investors, dragging even the growing Screen down with the sector.

The stock, down 3p to 73.5p, is on 20 times SG Securities' forecast of earnings this year – in line with the market, yet holding the hope of above-market growth. That may sound tempting, but the word is the broker could cut those forecasts when it combs through the figures, and the stock remains too risky.