Second-guessing ICI is a mug's game

The Investment Column

A lot of twaddle is written about ICI, largely by American brokers trying to justify the sophisticated models they have developed to value highly cyclical companies that don't respond well to traditional price to earnings measures. One recent heavy tome measured ICI's price relative to its cashflow, the replacement cost of its assets, its cashflow return on investment (whatever that might be) and a host of other clever but impenetrable ratios.

The conclusion of that work, written in May, was that ICI's shares, at 850p, had a long way to go, maybe as high as 960p a share. Yesterday, on relief that things were no worse at the third-quarter stage than analysts had feared, the shares closed 19.5p higher at 795p. It is arguable that the only statistic that really matters about ICI is the following: over the past year its shares have underperformed the market by 12 per cent, by 11 per cent over three years, 20 per cent over five, 24 per cent over seven, and a whopping 40 per cent over the past decade.

In other words, to have made money out of ICI at any point in the past 10 years you would have had to second-guess the chemicals cycle rather better than the highly paid experts can. Frankly, it is a mug's game trying to cash in on the flickers of life punctuating this slow decline.

To be fair ICI is attempting to reverse that relative decline with gusto, and has been doing so ever since Hanson gave the group the fright of its life five years ago with a threatened bid. Costs have been pulled out of the bloated behemoth like there's no tomorrow and the programme, the value-gap initiative in expensive consultant speak, continues apace.

To the untutored outsider, however, the benefits are currently pretty hard to spot. In the third quarter, ICI's most important division, Industrial Chemicals, made nothing at all from sales of almost pounds 1bn. The group as a whole saw profits slump from pounds 260m to pounds 147m in the three months to September. For the first nine months of the year, profits were down from pounds 793m to pounds 536m.

The problems were most acute in the bulk chemicals arm, but paints aside there was precious little to be cheerful about. Materials, such as acrylics and polyurethanes, increased profits by 12 per cent in the year to date, but the latest period saw a dip from pounds 58m to pounds 46m. Explosives profits are running a third lower than a year ago while the Australian and Canadian regional businesses also lag.

On the basis of profit forecasts of around pounds 650m for the full year and pounds 750m next time, the shares trade on a price/earnings ratio of 15 falling to 13. That is not demanding, but neither should it be for such a volatile profit earner.

Big institutions have no choice about having an appropriate weighting in ICI but nobody else should bother.

BAA throws its

cap in the air

BAA described yesterday's well-trailed five-year price cap from the Civil Aviation Authority as "challenging", but the 14.5p rise in the share price to 519.5p spoke for itself. BAA shares have risen by almost 9 per cent in the space of four days, suggesting the company's cautious public statements disguise a heavy sigh of relief at the laxity of its new trading regime.

From next April, increases in charges at BAA's two most lucrative airports, Heathrow and Gatwick, will be capped at 3 percentage points below inflation each year until 2002. Its other regulated airport, Stansted, will see charges increase by inflation plus 1 per cent.

In today's money this amounts to a cut in revenues of pounds 150m over five years, a drop in the ocean when you consider that BAA's forecast earnings for 1998, the first full year after the new controls come into force, will be pounds 500m. BAA voluntarily limits charges at the airports which are not regulated to inflation minus 3 per cent, suggesting the CAA's price cap on London airports will not be onerous.

In recent months BAA's share price has been hit by inevitable regulatory uncertainty, hardly surprising since at the same time regulators in other privatised utilities are getting tough over charges for British Gas's pipeline business or the National Grid. Yesterday's closing share price was still 35.5p below this year's peak of 555p in April, whereas the market as a whole has surged ahead in that time.

With the regulator pushed back to the sidelines for another five years, several teams of City analysts were yesterday suggesting the shares deserve a re-rating. One important consideration lost in the regulatory fog has been that the company earns almost half its income from retailing, where there should still be strong potential for growth.

According to the influential transport team at UBS, BAA shares have historically traded at a 20 per cent premium over the market as a whole. Restoring that differential implies a substantial upswing for the share price.

Expect pre-tax profits to rise from pounds 418m last year to pounds 460m this year. That would put the shares on a prospective price/earnings ratio of 15 next year, which is scant recognition of the potential for growth. Good value.

New-look Baird

wields the axe

No one could describe the restructuring at the textile struggler William Baird as half-hearted. David Suddens arrived as chief executive in May and gave fair warning that a full-scale review was under way. Yesterday he duly delivered with an overhaul that will include 500 job losses and exceptional charges of pounds 23m-pounds 28m.

The non-clothing businesses such as engineering and Christmas tree bauble distribution are earmarked for sale. Also on the block are some of the smaller brands with limited potential for development. These include a school clothing business and Berkertex, the bridalwear brand. The loss on disposals is expected to be pounds 10m-pounds 15m though this is included in the provision.

Going forward the company plans to concentrate on its business of supplying clothing to Marks & Spencer as well as other brands such as Dannimac and Centaur menswear. The shake-up is William Baird's second in successive years. In 1995 it took a near-pounds 10m charge to close one fabrics factory and reduce staffing at a men's suit plant undermined by cheaper foreign imports.

This time the review is more fundamental and strategic. It won support in the City with the shares unchanged at 191.5p in a falling market. Much still needs to be done, however. While Baird has limped along with margins of barely more than 4 per cent in its M&S supply business, rivals such as Dewhirst achieve 7-8 per cent.

To catch up the group plans to improve the design and marketing focus to build market share. Overheads will be reduced and productivity increased.

Mr Suddens is uneasy about the group's over-reliance on the UK market. An expansion into Asia, probably through acquisition or joint venture, is likely.

UBS is forecasting pre-exceptional profits of pounds 25m this year which puts the shares on a forward rating of 13. About right given the considerable uncertainties.