Pilkington remains under the cosh

The Investment Column
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The Independent Online
Roger Leverton has done a splendid job in the four years he has been at the helm of Pilkington. He has focused the company on what it does best, tried to add some value to its commodity glass businesses and shaken up the previously sleepy family culture. He has been rewarded with a trading background to make the strongest manager weep.

Profits of pounds 75m in the first six months to September were pretty much in line with expectations. Unfortunately, those expectations have been progressively massaged downwards in recent months.

It was only a few months ago that the consensus forecast for the full year was reined in from over pounds 250m to under pounds 220m. Now anyone looking for more than pounds 200m is being taken to one side and steered lower.

Those downward revisions matter for a company like Pilkington because its shares tend to be valued on the basis of peak expected earnings. If the timing of those top-of-the-cycle earnings is shifted outwards or the quantum reduced, the calculations used to justify the current price can be quickly rendered worthless.

No surprise then that Pilkington's shares have suffered so much from the growing realisation that the building markets of Europe remain severely under the cosh. At yesterday's close of 171p, the shares have fallen by a fifth since March and underperformed the rest of the market by a quarter.

In a commodity market like float glass, reduced demand and overcapacity can have a dramatic impact on price and a decline in overall volumes in Europe of 3 per cent was reflected in falls in price of up to 25 per cent in Germany, the worst-hit market. The good news is that the downturn would appear to have bottomed and prices are back to where they were six months ago, even if that still represents a sizeable decline from a year back.

The dismal performance of European construction has cast an unfortunate shadow over the rest of the group, which is actually performing quite well. The North American automotive market has been chugging along nicely for three years now and shows no signs of slowing. Even in Europe, the building malaise has not affected the car market where the consolidation of former Italian state- owned glass maker SIV helped sales double in the half.

On the basis of forecasts of pounds 190m for the year to next March and pounds 230m in the following 12 months, the shares stand on a prospective price/earnings ratio of 16, falling to about 13. For a company that should rightly trade on a significant discount to the rest of the market, to compensate for the volatility of its earnings, that does not appear unduly cheap and there is little support from a yield of under 4 per cent.

US weighs on Body Shop

Body Shop was sounding a lot more positive yesterday even though its problems in the cut-throat US market showed no signs of abating. Sales of facepacks and all-over body lotions are walking off the shelves in Asia, apparently. And the Australian business has boomeranged from loss to profit in the past year.

These developments were behind a 30 per cent hike in profits to pounds 11.8m in the six months to August. With the progressive dividend policy continuing with a near-40 per cent rise to 1.5p, the shares responded by ticking up 4.5p to 200p. Management is particularly bullish about prospects in Asia where there are 202 shops. This market accounts for more than half group profits and new stores are opening rapidly. The feeling is that Body Shop is viewed as a luxury goods retailer in the Far East, which may enable it to edge prices up on certain products such as its new skincare range.

But encouraging though this is, the real bellwether of Body Shop sentiment is its performance in America. Unfortunately for Body Shop investors, the company's performance there is still poor. Group like-for-like sales were up by 1 per cent across all markets. But they fell 4 per cent in the US and are 7 per cent down in the eight weeks since the end of the half year. US losses rose from pounds 2.4m to pounds 3.4m in the period.

The problem remains ferocious competition coupled with a product range and store portfolio not as good as it might be. Body Shop is up against rivals such as Bath & Body Works and Garden Botannica and customers are used to frequent changes of product and regular promotions. Rivals have been delivering, Body Shop has not.

The company has recruited Steen Kanter, who introduced Ikea to the US, to run its US division. The store opening programme has been slowed to enable management to concentrate on getting the existing business right. In the UK profits were flat but the Body Shop Direct home selling programme has been extended to 170 stores with more than 1,000 consultants.

Analysts are forecasting full-year profits of pounds 38m which puts the shares on a forward rating of 17. About right.

Worst may be over for Arjo

The collapse in paper prices since the middle of last year has hammered Arjo Wiggins Appleton. Persistent over-optimism about the state of the European market, and a restructuring plan that is seen by analysts as too little too late, have added to the group's problems as far as the City is concerned. After a switch-back ride, the shares, up 4p to 165p yesterday, are back almost exactly where they were at the start of the year.

The latest bout of cautious optimism is based on hopes that the worst may be over. Yesterday the group said sales in the first nine months of the year were up 3.9 per cent to pounds 2.7bn, including a 2.8 per cent gain in the third quarter. The bald figures are flattered by last year's acquisitions. Stripping out distortions, sales were down 7.4 per cent in the nine months and 3.2 per cent in the latest quarter.

Given price falls which saw pulp slump from $1,000 a tonne to $400 between last summer and this spring, that is not too bad a result and there are clear signs the market has bottomed out. While turnover slipped from pounds 895m to pounds 841m in the seasonally weaker third quarter, volumes were slightly ahead. Although there has been some restoration of stocks since February and March, the company denies seeing any significant stock-building amongst its European customers. Given previous failures to read the market, that view may prove optimistic and the European arena clearly remains highly competitive.

But the problem for Arjo remains that its key carbonless and thermal papers are in long-term decline, requiring continuous restructuring. Saint Louis, the dominant 40 per cent shareholder, has been wielding the big stick, but it is difficult to see where the excitement will come from unless it sells out. Profits could rise from pounds 130m this year to pounds 210m next, putting the shares on a forward p/e of 10. Fair value.