Conglomerates tarred with same brush

Conglomerates, or diversified industrials as we must learn to call them now, have lost their lustre of late as changes in accounting rules have made it more difficult for companies to grow through acquisitions, using hefty provisions to keep the City sweet with steadily rising earnings.

Companies like Williams and Hanson have changed their spots as a result and now tout themselves as business managers rather than deal-makers. The market has remained unimpressed and, after outperforming the All Share by 15 per cent between 1991 and 1993, they have steadily undershot the average ever since.

Research from Smith New Court takes issue with the broad-brush dismissal of the sector, however, suggesting that the factors continuing to hold back the big four conglomerates - Hanson, Williams, BTR and Tomkins - cannot fairly be applied to a raft of smaller groups for which the last five years have provided excellent returns.

While the net performance of the big four over the past five years has been to match the All Share, an index comprising Wassall, Berisford, TT and Stratagem has outperformed by an impressive 75 per cent over the same period.

Smith New Court puts this differential down to the natural life cycle of conglomerates whereby companies initially grow fast through acquisitions, then settle down to a period of less dramatic organic growth and finally fall victim to decadence and break-up.

This is a plausible argument. As companies grow, it becomes increasingly difficult to find undermanaged or underpriced businesses of a sufficient size to make a mark on the group as a whole. The big four are clearly in the second phase of the cycle.

The smaller companies, whose market values range from Stratagem's £32m to Wassall's £472m, still appear to have plenty of growth left in them. All have made interesting acquisitions recently and are expected to continue to do so.

Even though the group as a whole has produced historical earnings growth well in excess of the market average and is expected to continue doing so, the shares stand on prospective p/e multiples at or below the market's.

Either the market does not believe the growth expectations or it is attaching a high-risk premium to the shares. Obviously, the rate of earnings growth will slow as the companies increase in size and follow the larger conglomerates into the mature phase of the cycle, but that is a way off yet.

As for risk, there is nothing to suggest that any of the four wannabes are intrinsically any more dangerous than the market as a whole. It would be foolish to write-off the conglomerates en bloc.

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