Kodak improves Danka's image

The Investment Column
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Danka Business Systems is hardly a household name, even in the City, but that has not stopped it mounting a whirlwind of acquisitions which have transformed a one-time oil and gas company into the world's fourth-largest photocopier distributor. In 10 years the company, led by executive chairman Mark Vaughan-Lee, has made around 140 purchases, culminating last year in the $688m (pounds 434m) purchase of Eastman Kodak's office imaging division.

That deal was done at below net asset value, but the effects of writing off around pounds 450m in goodwill since 1987 and the huge borrowings taken on with the Kodak deal have left a balance sheet looking like an inverted triangle. Some pounds 524m of net borrowings now teeter on shareholders' funds which were a mere pounds 7.41m in March, down from pounds 11.9m the previous year.

Mr Vaughan-Lee remains unworried by the gravity-defying structure of his balance sheet, pointing to an interest cover of 4.5 times which is set to rise as the group pays down "substantial" amounts of debt. Already, with the acquisition under its belt for only the fourth quarter to March, Danka has repaid around pounds 100m in borrowings from cash flow. It is set to receive another $86m (pounds 52m) as part of a price adjustment with Kodak.

Kodak has transformed the business. The first results to include the operations yesterday were marred by the pounds 45.6m cost of integrating acquisitions. Pre-tax profits slumped from pounds 53.9m to pounds 29m in the year to March, hit also by higher finance charges on the increased debt, with the interest bill soaring from pounds 15.3m to pounds 22m.

But profits before exceptionals ahead 23 per cent to pounds 75.2m were well ahead of expectations and the deal has proved earnings-enhancing on an underlying basis. More important is the potential. Having decided to fully integrate the Kodak business, Danka reckons it can squeeze out annual cost savings totalling $100m by the end of the second full year of ownership. The target is to raise meagre operating margins of 2.7 per cent at the time of the purchase to the 9 per cent average for the rest of the group over the next two to three years.

The group has done it before with Infotec Europe, previously its largest acquisition, which has seen margins nearly quadruple to the group average in 18 months or so. But that was a much smaller deal and Danka has suffered hiccoughs before: last year the shares suffered a 28 per cent one-day fall after it warned that reorganisation in the US would hit profits.

That said, Kodak still looks a good deal, bringing on board stringent financial controls and much faster-selling products. The growth rate for Kodak's high-volume photocopiers at around 7 per cent is several times that for Danka's traditional products and its outsourcing business is in one of the most exciting areas of the market.

Profits of pounds 111m for Danka this year would put the shares, up 20p at 567.5p, on a forward multiple of 17. Fair value.

General Accident

pauses for breath

General Accident's shares have had a stunning run in recent weeks as the increasingly carefree stock market has abandoned its traditional valuation measures for composite insurers. Historically, GenAcc, Commercial Union and Royal Sun Alliance have traded at a discount to net assets to reflect the inherent cyclicality of their underwriting business, but the heady premiums they all attract now mean the shares have moved into uncharted territory.

First-quarter figures from General Accident yesterday showing an operating profit of pounds 114m were well ahead of expectations and a marked improvement on last year's pounds 55m profit. Star of the show was underwriting, where the world-wide loss was reduced by pounds 50m in what is traditionally the worst quarter. Producing an underwriting profit of pounds 6m in the home market was an impressive performance unlikely be matched by CU today or Royal when it reports soon.

What appears to have happened at General Accident is a steady improvement in its ability to interpret the wealth of statistical data that all insurers have at their fingertips, but which they have in the past failed to understand properly. As a result, the group is more selective about unprofitable business, thus bringing the quality of earnings from its general insurance arm closer to that of its long-term life business.

In the latter division, the acquisition last year of Provident Mutual has been absorbed more effectively and quickly than any observers thought likely. With margins on the increase, profits moved usefully ahead from pounds 22m to pounds 32m in the period.

That and a very strong balance sheet mean a forecast 10 per cent dividend rise this year looks achievable, putting the shares, even after their sharp rise, on a prospective yield of 5 per cent.

The income should provide some support for the shares, but valuing General Accident and its peers with confidence is difficult now the traditional net asset value yardstick has been left behind. On the basis of the 723p NAV announced yesterday, the shares, which closed 5.5p lower at 957.5p, trade at a 32 per cent premium. That compares with a likely premium of about 25 per cent for CU, which arguably should enjoy a higher rating thanks to its bigger life business. After a strong run, the shares are now likely to pause for breath.

BOC chief faces profitability test

Is BOC about to shrug off its big, boring, yet accident-prone image? At least under Danny Rosenkranz, chief executive, the reputation for steady progress marred by unexpected slip-ups is slowly being eradicated. The real test will be whether he can deliver the step change in profitability over the next two years forecast by many analysts, but held back by BOC's heavy capital investment programme.

Yesterday's modest drop in half-yearly profits to pounds 216m, from pounds 217m a year ago, suggested the problem parts of the business have at long last hit bottom. Were it not for the strong pound, which knocked a total of pounds 23m off the bottom line, with pounds 45m expected for the full year, earnings would have risen by more than 6 per cent. On a similar basis, underlying gas profits, which rose just 1 per cent to pounds 199m, would have increased by 9 per cent.

Unlike the damage being sustained at British Steel and ICI, the kind of hit from sterling experienced by BOC is pretty limited and mostly due to the effect of translating earnings from overseas currencies into sterling, rather than a genuine impact in cash terms. The fear is that sterling could have a longer-term effect on the group by depressing demand from manufacturing industry for industrial gases. Thus far this has been offset by growth overseas. Mr Rosenkranz said demand from his customers was flattish, but did not see things getting any worse.

News from the once fast-growing vacuum pump operations was more encouraging. Despite a 20 per cent fall in operating profits to pounds 24.9m and a drop in export margins as a result of the exchange rate, there are signs of a slow recovery. Which leaves healthcare, another exporting division hit by sterling, where profits fell 8 per cent to pounds 26.1m. The big concern is the decision by the Food and Drug Administration, the US drug regulator, to extend the patent on Zeneca's rival anaesthetic drug. This was disappointing and has yet to make its impact on the figures.

A full-year profits forecast of pounds 450m leaves the shares, up 9.5p at 984.5p, on a prospective p/e ratio of 16. Worth hanging on.