Dewhirst profits from Marks & Spencer

The Investment Column
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The Independent Online
Investors cautious about years of dismal returns from the textile sector should take more than a second look at Dewhirst Group. In stark contrast to its peers, Dewhirst has used the recession to squeeze ever higher margins and profits out of the famously cutthroat business of supplying Marks & Spencer. The result has been a share price that has outperformed the rest of the textiles and apparel sector by nearly 680 per cent in the past five years, even after yesterday's 3p downtick to 186p.

That reaction in the shares was a little perverse in view of another cracking performance from the group in the year to 12 January. Pre-tax profits up 31 per cent to pounds 22.3m were in line with market expectations and came after a year in which rivals have blamed strong raw materials prices and the hot summer for less than sparkling results.

It is hard to pin down a single factor for this performance other than simple good management, which is something of a surprise in a company still dominated by the founding family. Including the honorary president, there are still four Dewhirsts on the board and the family controls a quarter of the equity.

But sentimental considerations did not prevent Dewhirst reorganising its UK manufacturing base early on in the recession, a move which has stood it in good stead. While others, notably leading M&S supplier Coats Viyella, are only belatedly attempting to source more clothing offshore, Dewhirst's overseas manufacturing operations have allowed it to undercut the competition and win market share.

With over 13 per cent of the market supplying M&S, it is reckoned to have narrowed the gap with second-placed Courtaulds Textiles to around one percentage point in 1995. Continued sales growth at last year's rates - 12 per cent in ladieswear and 15 per cent in menswear - should have Dewhirst snapping at Coats 20 per cent-odd share before long.

The group's expansion overseas is being stepped up this year. After two years holding capital expenditure at just over pounds 8m, the budget for 1996 has jumped to between pounds 14m and pounds 15m, with most of the money earmarked for new plants in Morocco and Indonesia to replace existing third-party sources. Dewhirst sees nearly all its future sales growth being met by overseas supplies, which could mean 50 per cent of the business being sourced from outside the UK by the year 2000.

Given the continuing fight for sales on the high street, this greater control over a lower-cost manufacturing base may not help margins in the short run. But, after more than doubling from around 3 per cent five years ago, the margin story is not over yet at Dewhirst. Last year saw operating margins rise another 1 percentage point to 7.8 per cent. With raw materials prices stabilising, after rising between 5 and 7 per cent last year, the omens are good.

Profits of pounds 25.5m this year would put the shares on a prospective price/earnings ratio of 14. Still reasonable value, assuming M&S maintains its grip on the high street.

Hang on to Recs

left in the cold

If there is a bid looming for Yorkshire Electricity, nobody has told SBC Warburg. The investment bank is thought to have reduced its stake recently to under 0.3 per cent.

As with the other three Recs still left on the shelf without an approach - East Midlands, Northern and London - speculation has driven the share price sharply upwards in the past few weeks. More informed observers in the City, including SBC Warburg, have had a tough job explaining why.

The most popular suggestion is that a bid for one or more of the four awaits only the verdict of the Monopolies and Mergers Commission on the PowerGen bid for Midlands Electricity and the National Power bid for Southern. The likely bidders, according to this story, simply want to see the small print of the report before they make a move.

The two bids were referred late last year and Ian Lang, President of the Board of Trade, is due to announce his decision in the next few weeks.

The only other big generator known to want a Rec, British Energy, cannot do anything at the moment because it is not to be privatised until June. It is questionable whether it could afford a Rec, even with the lower- than-expected debt level with which it is to be sold.

The result of the inquiry and Mr Lang's decision is likely to be irrelevant to any of the overseas bidders rumoured to be still snooping around the Recs, because vertical integration is not an issue with them. Other foreign bids were cleared with alacrity last year.

As for a counter-bid for Midlands or Southern, the only sensible time to do that was soon after the references were made. The bid timetable would have allowed shareholders to reach decision point well before Mr Lang's pronouncement on the PowerGen and National Power offers, an unbeatable tactical advantage.

But as with many of these movements, the share price may be telling the right story for the wrong reason. The four remaining Recs are only marginally less attractive than those that have been sold.

Northern is often said to have spoiled the chances of a bid by giving away so much cash to shareholders, and raising its gearing. But the share price adjusts for that, so the mix of debt and equity should make no difference to a foreign cash bidder.

It is more than likely there will be further bids. But the reason is the simpler one that these companies do not have the strengths required to remain independent distributors as domestic deregulation approaches in 1998. For that reason they are worth holding onto.

Newcomer FI

priced right

Technology flotations got a rather tarnished image last year as investors burnt their fingers on new issues such as MDIS and MAID. There are many different aspects to the information technology sector, however, and it would be wrong to tar FI Group, in which dealings start today, with some of the more blue-sky, speculative stocks.

The applications and facilities management end of the market in which FI specialises is a reliable, predictable business, the quality of earnings it generates is improving as contracts lengthen and the market as a whole is growing fast. The driving force behind the growth in FI in recent years has been an increasing trend towards outsourcing of information technology functions. Companies have decided that they are better off concentrating on their core activity and paying a specialist to run their computer systems.

That should pave the way for a continuation in the growth of FI's profits, up from pounds 1.3m in 1993 to pounds 3.3m in the year to April 1995. In the most recent interim period ending last October, profits increased to pounds 2.1m.

There is no faulting the timing of FI's flotation, in the form of a placing of 7.9 million shares at 235p a share. Over the past year the software and computer services sector has outperformed the market by a sizeable margin.

On the basis of forecast earnings per share of 11.3p for the year to the end of this month, the placing price represents a price/earnings ratio of 21. That puts the shares in the middle of the pack, cheaper than Capita, more expensive than Logica. About right.