Paper-thin margins at David Smith

The Investment Column

David S Smith, the corrugated paper to office supplies group, has done well in an uninspiring sector over the years. But now even it has succumbed to the extraordinary turbulence the industry has faced since 1994.

Yesterday's 7p fall in the shares to 299.5p came after the group warned it would be hit by the combination of the high sterling exchange rate and flat European economies, to which around half Smith's business is exposed. Profits will dive in the second half, the group warned, and the bad times could extend into next year.

The warning overshadowed interim results which showed profits edging down from pounds 59.6m to pounds 58.6m in the six months to 2 November. The figures were hit by falling paper prices and, more importantly, their margin over waste paper, a key raw material for Smith, which has been on a downward trend since last year's peak. The squeeze exerted by sluggish continental economies is being exacerbated by the pound's strength since August. This is giving European rivals a financial incentive to flood the UK. Smith chief executive Peter Williams reckons imported recycled grades for corrugated board have captured about 20 per cent of the home market.

Given European capacity increases coming on stream totalling around 4 per cent, sentiment is not going to improve until the second half of 1997. But the decision to raise the interim dividend by 6.1 per cent to 2.6p reflects the group's underlying optimism. Mr Williams points to rising corrugated production and, more significantly, demand in Europe, which is up 6 per cent in the third quarter of 1996.

Paper, mainly the St Regis business, is now down to just 27 per cent of Smith's sales and the much bigger packaging division is said to be doing well. But both this business and Spicers, which dominates UK office supplies wholesaling, are still suffering from intense competition. Beyond that, any strengthening of the pound above 2.60 marks would start to hurt Smith badly, while the effect of the recent strikes in France remains unquantifiable. Brokers have eased forecasts to somewhat below pounds 110m, putting the shares on a prospective multiple of 11. Certain directors sold at well above 300p in the autumn. Others should wait until the uncertainty clears before buying again.

NFC clear-out pays dividends

Since becoming chairman two years ago, Sir Christopher Bland has presided over a wholesale clear-out of directors at NFC, the Exel Logistics and Pickfords transport group. Out went all but one of the old guard; in came a new management team led by chief executive Gerry Murphy to attack a bloated cost base and weed out underperforming businesses.

Yesterday Sir Christopher was in no doubt the often painful and expensive turnaround process was beginning to bear fruits and he was right to boast that for the first time the company was "delivering a proper set of results".

The headline figures make impressive reading. In the year to September, pre-tax profits before exceptional items rose by 39 per cent to pounds 105.7m on sales 12 per cent higher at pounds 2.46bn. Underlying turnover rose by a more pedestrian 5 per cent. The maintained dividend of 7.1p was covered by pre-exceptional earnings of 9.3p (6.9p).

In the light of that performance it was telling that the shares, which have outperformed the market by 14 per cent this year, fell 5p to 175p. The problem appears to be that some of the businesses which almost brought NFC to its knees remain in the portfolio. NFC is still lumbered with the late Eighties legacy of a failed attempt to build a pan-European distribution system. In Sir Christopher's succinct assessment: "We bought a clutch of lousy businesses. We can't exit bad businesses so we must turn them around."

Although losses in Europe narrowed to pounds 8.5m from pounds 10.1m on sales of pounds 373m, the network logistics business is having a torrid time, especially in France, where the cost of creating an integrated national network continues to cause headaches.

Broker UBS trimmed its 1997 pre-tax forecast by pounds 3m to pounds 122m to take account of sterling's recent strength against the dollar - North America is almost a third of sales - and the cost of the French lorry drivers' strike.

NFC expects to complete its pounds 30m restructuring programme this year, but the next, and more difficult task, will be to grow the business in what it admits are "challenging market conditions." The prospective p/e rating of 16 looks generous given these uncertainties. High enough.

Cider sales still fizz for Bulmer

If proof was needed that the problems round at Matthew Clark were of the Taunton cider maker's own doing, half-year figures from rival HP Bulmer provided it. Despite Clark's protestations earlier in the summer that the rapid growth of alcopops had knocked the cider market for six, Bulmer's 8 per cent profit increase in the six months to October suggested otherwise.

The key difference between the two companies lies in their approach to managing brands. Bulmer, under former marketing man John Rudgard, has put its faith, along with most of the drinks industry, in investing heavily in brand-building and it plans a big pre-Christmas press and poster offensive.

Matthew Clark has taken the opposite tack, one it appears to have realised was misguided, by cutting back on advertising and attempting to boost volumes by selling its Olde English and Blackthorn ciders at a marked discount to its rivals. Bulmer provided clear evidence yesterday that that approach had failed.

While volumes in the take-home trade have grown by 17 per cent over the past 12 months on average, Bulmer's brands are 42 per cent ahead. In the more difficult on-trade, where nitrokeg beers are a stiff challenge, Bulmer's 3 per cent volume decline was better than the market's 5 per cent fall.

Against that backdrop, profits of pounds 17.4m, up 8.4 per cent, were in line with expectations. Earnings per share rose 9 per cent to 21.1p and the dividend rose 8 per cent to 4.9p.

The key issue moving into the second half, which includes the crucial Christmas period, is pricing. Bulmer has already signalled a 5 per cent increase, similar to the rise it failed to make stick last year. If it can do so, then rising volumes at home, better prices and early signs of success in its overseas expansion strategy augur well.

Expected profits of about pounds 30m this year and pounds 33m next time put the shares, down 2.5p to 545p, on a p/e ratio of 15 falling to 13. About right.