Farnell keeps up the good work

THE INVESTMENT COLUMN

Farnell has been one of the great investments of the past 30 years since the electronic components distributor came to the market. Buying 1,000 shares at flotation (and taking up the rights issues since) would have cost about £2,500 - a stake that would now be worth £661,000 even without reinvesting dividends.

A 27 per cent jump in pre-tax profits for the year to January to £62.1m confirmed that Farnell's dominant position in the UK market, where it slugs it out with equally successful Electrocomponents, continues to pay off. Earnings per share were up a similar amount to 30.9p and the well- covered dividend was increased 22 per cent to 9p a share.

Despite the fact that the UK has one of the most mature and sophisticated distribution markets in the world, underlying sales at home grew strongly both in the high-margin, catalogue-based businesses for small-batch orders and at the high-volume commodity end.

Overseas, where Farnell plans to devote its expansion efforts, sales from the catalogue operation advanced by 40 per cent, and new operations in Germany and France are moving into profit ahead of schedule.

Future performance depends crucially on that expansion because, since the disposal of its small manufacturing operation, Farnell has almost £100m burning a hole in its pocket. Getting the 40 per cent return on capital it achieves from its distribution business would generate profits of almost six times the £7m it made from making power supply equipment last year.

Which almost sounds too good to be true, but Farnell is nicely cushioned from competition because the barriers to entry are dauntingly high for any would- be rival. With 40,000 items in stock, 99 per cent availability for any catalogue item and guaranteed next-day delivery across Europe, the required investment in computerised systems would be immense. Farnell's customers, buying a 5p component, are quite prepared to pay 6p for the comfort of that sort of service - on a small order the extra is immaterial, but for Farnell it spells fat margins.

Expansion is likely to be focused on the US, where a relatively primitive $5bn market beckons with only two or three serious national players. Plans for a move into the Far East are also advanced.

Mike Styles, at Credit Lyonnais Laing, believes profits of £75m this year and £86m next are possible even if the cash is left in the bank. On a forward price/earnings ratio of 16 falling to 14, the shares, 5p lower at 585p, already discount much of the good news. But with strong management, a growing market and fast-increasing dividend payouts in prospect, they are still good value.

If FT-SE companies competed for communications prizes, there would be little danger of Garry Weston's Associated British Foods troubling the judges. Along with other detail-shy groups such as Great Universal Stores, ABF doesn't exactly overburden its investors with information, but yesterday's half-year results showed that in some markets the company is finding the going tough.

The impact of the bread wars is still hurting ABF, which controls 35 per cent of the UK bread market. Packaging costs are rising but the baker is struggling to add the increases to the price of a loaf of Sunblest. Even in retail, where the Irish supermarket price war with Dunnes has drawn to a close, ABF has failed to make the new regime pay at subsidiaries such as Quinnsworth's and Crazy Prices.

Though group sales were up around 10 per cent to £2.2bn for the six months to March, pre-tax profits fell from £181m to £173m. The shares eased 16p to 638p.

Of the operating subsidiaries, British Sugar was the star performer, improving profits from £77m to £84m. Profits at the rest of the UK manufacturing operations were flat. Stripping out acquisitions, UK profits would have fallen by more than £1m. Profits at Allied Mills fell due to falling bread- flour prices, feed merchanting and grain trading are struggling and the Twinings tea business turned in poorer results as a result of strong competition in Europe.

But with £600m in the bank (£398m at the half-year), the big question remains where ABF might spend its hoard. Rumours of any interest in perennial bid target United Biscuits look wide of the mark for such a conservatively managed company. Going further down the brand route also looks like the road to nowhere in the current retail environment. Food ingredients is likely to prove the more likely, if prosaic, option. ABF swallowed the US interests of Karlshamns, last October and more, though smaller, add- on acquisitions are expected in this sector.

Smith New Court is forecasting profits of £348m for the full year which puts the shares on a prospective p/e of 12.5, a slight discount to the sector. However, with a good run already behind them this year, the shares look to be losing momentum. High enough for now.

Everything appears to be coming up roses for McKechnie, the former West Midlands metal basher that has repositioned itself in higher value-added businesses ranging from plastic mouldings to fasteners.

Latest results show the group has shrugged aside large cost increases to produce pre-tax profits 53 per cent ahead to £20.2m in the half-year to January, with all divisions now contributing following a £3.7m reversal into the black at the US plastics businesses.

The board, chaired by BBA chairman Vanni Treves, is celebrating with the first dividend increase for five years. The interim payout rises 10 per cent to 5.5p.

On the face of it, the group's acquisition strategy has paid off handsomely. Despite close to £50m of acquisitions during the latest 18 months or so, earnings per share have largely kept up with profits, rising 43 per cent to 14.7p in the half-year.

Last year's big buy, the £26m purchase of the Linread fasteners group, probably chipped in close to half McKechnie's £4.2m profits growth from acquisitions. Plastic Engineers, acquired for £5.1m, probably added a further £1m.

Analysts point out that large provisions - £3.1m this time and £3.3m in the comparable period - have enabled the group to shelter profits from rationalisation costs. Meanwhile, "organic" growth of £4.2m was heavily influenced by the US turnaround.

Profits of £46m this year would put the shares, up 6.5p to 425.5p, on a forward multiple of close to 13. Margins should benefit from further recovery in the US, but McKechnie must still prove it can squeeze real growth from European businesses heavily dependent on the automotive and home improvement markets.

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