REC shares look unlikely to set the world alight

The Investment Column
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The Independent Online
When we last wrote about the electricity sector, in July, Professor Stephen Littlechild had announced a new regulatory regime for the regional companies. The review was broadly welcomed by the City and we predicted further upside in the shares - the rise since then has been a useful 14 per cent.

The defining development this week has been the decision by Ian Lang, President of the Board of Trade, to wave through all three of the ongoing bids, for Eastern, Manweb and Sweb. Open season on the remaining nine companies was deemed to have been declared and shares rose sharply across the sector on Thursday and, more modestly, yesterday.

The question now is how much of the good news is in the price. If most has already been factored in, should shareholders pocket the 20 per cent capital growth over the past three months or try to squeeze out a few more per cent?

Working out the value of a regional electricity company is a complicated sum-of-parts exercise, which seeks to strip out assumed values for the RECs' shares in the National Grid, and any other special dividends that might be paid to shareholders before assigning a value, based on yield, to the rump.

The calculation is different for each company, depending on its shareholding in the Grid, its gearing and the extent to which it wants to build up its borrowings to give shareholders a one-off payment, and finally the yield premium to the market that fairly reflects its earnings and dividend growth prospects.

James Capel, the broker, has run calculations on the nine companies, making the following assumptions: that the Grid is worth about pounds 4bn; that the RECs will increase their gearing to 75 per cent, giving themselves the lee-way to sustain any windfall tax imposed by a future Labour government; that the companies will grow their dividends at an average 8.5 per cent a year until the year 2000; and that they should give investors a yield premium of 60 per cent to compensate for political risk.

Crunching those numbers, the broker arrived at target share prices extremely close to yesterday's closing levels, suggesting that the market is now fully valuing the companies' fundamental attractions.

At this level it would be rash to buy any of the nine on the basis of bid speculation - arithmetically, there is only a one- in-nine chance of getting it right, even if much of a premium is paid for control. Existing shareholders could take profits or simply hold on for the chance of a bid and a still-growing income stream.

Fertile ground

for Isotron

Sterilising medical equipment with germ-killing irradiation has been a steady but unspectacular earner over the years for Isotron, so the strong run in the company's shares, up from 237p in April to 305p yesterday, is slightly puzzling. Full- year results, showing pre-tax profits rising from pounds 3.07m to pounds 3.29m in the year to June, continued the trend.

Broadly in line with expectations, they meant earnings crept ahead from 17p to 17.3p. The outlook, however, is rather brighter. A new pounds 4.5m Irish sterilisation plant, held back by last year's start-up tests, is almost back on track. The first- year trading loss of pounds 232,000 was nearly all incurred in the first six months to December and the plant should start moving into profit in the current half.

This should eventually prove a nice little earner for Isotron. The company has, in effect, created a new market for sterilisation of medical devices without using soon-to-be-banned CFC gases. As a result, it has tied up 18 customers in southern Ireland, representing most of the big US healthcare groups operating there.

The first two production lines are already running at close to full capacity and work on a third, at a cost of pounds 750,000, will start in the next three months.

Excluding Ireland, operating profits from the rest of the business advanced 13 per cent. Growth was led by the tubing and wire coating business, which uses technology similar to shrink wrapping and saw sales advance 23 per cent. Isotron has been able to ride out the traditional boom-and-bust cycle in the car industry it supplies because of the increasing use of sophisticated technical components that require Isotron's shrink coatings.

The company is actively looking to expand, possibly in Europe and possibly in the area of microbiology, where it has expertise. But it will be hard- pressed to use all of its cash pile, which rose a further pounds 1.15m to pounds 3.47m last year. Profits should break out of a recent plateau to top pounds 4m this year, making the shares reasonable value on a prospective multiple of 14.

The sun shines

on Wyevale

Summer heatwaves can be a mixed blessing for garden centres: a few days of sunshine boost sales of barbecue products and garden furniture, but a long, hot spell dents sales of plants and shrubs.

Overall, however, the net impact is positive as sunshine engenders that elusive feel-good factor. Wyevale Garden Centres, Britain's largest garden centre group, should provide evidence of the link when it reports half- year results next week. Profits are expected to increase from pounds 6.7m to pounds 8.7m in the six months to June.

Wyevale's strength is that it is a relatively large player in a highly fragmented market. There are more than 2,000 garden centres in Britain, most small and privately owned. With 45 outlets, Wyevale is not only the largest operator but the only one with a nationwide presence.

Three years ago it acquired Cramphorn, one of the few other quoted garden groups at the time. The only other quoted company in the sector now is Country Gardens, which moved to AIM in June. Last week it reported a 34 per cent jump in profits to pounds 1.34m in the six months to June.

Shares in both have done well since last year. Wyevale shares have risen from 140p last summer to yesterday's 187p. Country Gardens has done even better, blooming from 35p last December to 66p yesterday, up a further 10 per cent on the results.

Size brings greater buying power and enables garden centres to compete against the DIY sheds that are increasingly moving into gardening products. Sainsbury's Homebase is particularly strong in the sector and will be adding garden centres to many of the Texas Homebase stores it acquired earlier this year.

Wyevale's recent performance looks promising. Like-for-like sales have been increasing at around 5 per cent and margins have held up. NatWest Securities is forecasting full-year profits of pounds 6.9m for the full year which puts the shares on a forward rating of 15. About right.


Turnover pounds Pre-tax pounds EPS Dividend

EFT (I) 7.53m (4.28m) 2.04m (1.24m) 3.18p (2.57p) 0.6p (0.53p)

Isotron (F) 8.83m (7.75m) 3.29m (3.07m) 17.3p 17.0p 3.42p (3.11p)

Riva Group (I) 34.72m (27.02m) 58,000 (L629,000) L0.2p (L2.5p) - (-)

(Q) - Quarterly (F) - Final (I) - Interim