European rivals muscle in on Smith

The Investment Column

Poor old David S Smith. If proof were needed of the havoc that the strong pound is having on British manufacturing industry, the recent travails of Britain's biggest converter of recycled paper should provide it.

The 33 per cent appreciation in the currency against the German mark over the past year has been a gift to Smith's European rivals.

Hurting under the impact of depressed markets at home, French and particularly German paper companies have finally woken up to the fact that, since the end of 1995, British prices have been anywhere between 25 and 100 per cent better than they enjoy at home.

The result has been a flood of imports, which have risen from 14 to close to 19 per cent of the UK waste-based paper market in a year, and a corresponding collapse in profits at Smith.

The pre-tax total crashed 23 per cent to pounds 96m in the year to 3 May, despite a mere 4.5 per cent slippage in sales. Although packaging and office supplies account for around three-quarters of the business, nearly all the problems were concentrated in the remaining paper operations, which are the most exposed to foreign competition.

Profits fell off a cliff in the second six months as the pound started to take off, with the bulk of the pounds 29.2m drop at the operating level coming in the St Regis Paper division, although there was also a pounds 2.5m hit on translation of profits from the European businesses.

Peter Williams, Smith's chief executive, resolutely refuses to be too gloomy, but he warns that two of the more marginal of the group's 10 paper mills could be vulnerable to closure. Certainly, the outlook in the short term is for more of the same.

The latest results were struck with the pound averaging DM2.50. Since the year end sterling has moved to over 3, while waste-based corrugated board prices, already down 17 per cent on the year, have slumped a further 5 per cent or so to under pounds 215 a tonne.

Credit Lyonnais Laing, the company's own brokers, are now forecasting a pounds 40m to pounds 45m impact from exchange rates in the current year, leaving profits cut to a mere pounds 62m.

There are glimmers of light. Volumes and prices have started to move up again on the Continent and Mr Williams believes few of his competitors are making money, which may prompt them to pull in their horns.

Worries over additional capacity due to come on-stream may also be overdone, while longer term the UK's belated decision to adopt the EU directive on recycled paper should boost Smith.

More significantly for investors, perhaps, some of Smith's directors have started buying shares again this year.

Although the forward multiple of 13 does not look unduly cheap, the share price of 185p, down 5.5p, is now close to net asset value and could attract takeover interest from more highly rated foreign groups. But only the brave will buy now ahead of a decisive turn in the value of the pound.

Medeva falls on profit warning

Until now, Dr Bill Bogie's Messianic enthusiasm for Medeva's products has been endearing. That a drug company which specialises in treating hyperactive children should be led by a doctor who behaves as if he is on speed has always led to wry smiles in some quarters. However, Medeva's profits warning yesterday and tumbling share price did little to alter Dr Bogie's mantra-like sermon on strategy and suggests a worryingly blinkered view by the chief executive. Whether Dr Bogie acknowledges it or not, Medeva may struggle to get exciting growth over the next few years.

Having paid pounds 260m last June for US drug manufacturer Rochester, Medeva finally looked like it could shake off its one-product company tag. At present, hyperactivity drug Methylphenidate contributes over a third of sales. However, one of the potential jewels from the Rochester acquisition lost its shine yesterday. Sales of Ionamin, the anti-obesity drug and Medeva's second-biggest product, collapsed from pounds 21m in the second half of 1996 to pounds 7m in the first six months to June. Part of the decline was a stocking issue, but new fears in the US that the drug causes leaky heart valves will mean flat second-half sales. Analysts were forecasting pounds 42m for Ionamin this year.

Therein lies a problem with Medeva's strategy of picking up small, mature drugs ignored by others. Having paid a premium to buy them, the buyer sometimes then discovers why no one else bothered.

Meanwhile, Methylphenidate's sales growth is slowing. By next year there could be three other generics in the US vying for Medeva's 70 per cent market share. As a quota-controlled drug, sales should not free-fall, but will slip by at least 10 to 15 per cent a year. Whether Medeva has enough drugs to drive it forward is unclear. The group reckons its hepatitis vaccine could be a blockbuster and promises clinical data in September. Ex-Ionamin, Rochester's sales rose 16 per cent, with Tussionex for coughs looking encouraging, but the new bladder cancer drug unlikely to be significant.

NatWest Securities has cut 1997 forecasts by pounds 7m to pounds 114m. Even on a lowly multiple of six times forward earnings, the shares, down 13 per cent at 222p, should be avoided for now.

Bulmer fights back against alcopops

The cider industry has been far from rosy over the past few years. Alcopops, those dreaded alcoholic soft drinks, have spread like wildfire. So too have a host of new, creamy, smooth beers, such as Caffrey's, which have wrenched market share from the cider makers. Throw in indifferent summer weather last year and fierce competition from supermarket own- label brands and it is hardly surprising that the cider market has declined by 3 per cent in the past 12 months.

HP Bulmer, the UK's largest cider maker, has coped better than most, especially its nearest rival, Matthew Clark, which has had a torrid time. Bulmer's pre-tax profits for the year to April rose by 9 per cent to pounds 30m. But margins are on the wane and it will become increasingly difficult to grow profits at a decent rate if the latest market slump turns into long-term decline.

So Bulmer has decided to spend its way out of trouble. In an attempt to lead the fight back against alcopops it is launching an pounds 8m advertising blitz. It hopes that its marketing drive, along with Matthew Clark's commitment to up its own spending, will wean the all-important 18 to 24-year-old market off beer and alcoholic lemonade and back to cider. It has also spent another pounds 500,000 launching Strongbow Smooth, the cider industry's answer to Caffrey's.

Past history suggests Bulmer's radical plan will work. Eight years ago it risked everything by ramping up its marketing campaign in a desperate attempt to arrest what looked like a terminal decline in the cider market. The City was dubious, but since then the cider market has almost doubled and profits have flowed accordingly.

But Bulmer is still taking a big gamble and the jury is out on whether it will pay off this time. The extra investment will blow a hole in earnings. Analysts now predict that pre-tax profits will be flat this year. And the spectre of higher excise duty on cider, aimed at discouraging under- age drinking, could be just around the corner.

Bulmer may be the best company in the cider industry, but the shares, down 2.5p at 472.5p, on a p/e ratio of 13, look high enough.

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