Investment Column: Ashtead is equipped to continue growing

Johnson Service; SQS Software Quality Systems

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The Independent Online

Our view: Buy

Share price: 133.2p (+21.2p)

Ashtead positively wowed the market yesterday, as the industrial equipment hire company said it expected profits for the full year to be well ahead of analysts' estimates.

The shares have fallen by a third in the last three months, largely because of concerns over the impact of the faltering US economy on construction activity. As it turns out this is not quite the problem for Ashtead that it appears to be. The company has highlighted a "structural change" in the US rental market.

It has long been the case that during periods of economic difficulty construction companies and the like have preferred to rent rather than buy. However, this time around, even if the US economy starts showing consistent growth, cash is likely to be thin on the ground, particularly as public spending is reined in to deal with the country's huge deficit.

The net effect is that companies are likely to switch to renting for the medium, and perhaps long term, rather than committing scarce capital to buying and maintaining their own fleets. Even more so for public bodies, such as US local authorities (and that applies to other countries, too).

The proof of the pudding can be seen in the first-quarter figures. Ashtead's profits increased by 184 per cent to £33.8m. At constant exchange rates they more than doubled.

Debt looks to be manageable, at 2.8 times earnings before interest charges, tax, depreciation and amortisation. That is down from the 3.1 times the level seen last year, and is within company targets. None of it matures any time soon.

This happy position means that Ashtead has been able to renew its fleet, and newer kit merits a premium rental charge. Other, smaller, competitors will find this tougher.

We were buyers at 110.2p last June, then again at 158p in December. The shares have not yet recovered to that level, but the sell-off was clearly unjustified. On valuation grounds they still trade at just above 11 times forecast earnings, after the recent upgrades. And that falls to single figures the next year. We're strong buyers.

Johnson Service

Our view: Buy

Share price: 31.25p (unchanged)

It's fair to say that Johnson Service has a low profile compared with other businesses that consumers come into regular contact with. But the firm, which provides facilities management services to shops and schools, and lends bed linen and towels to hotels, has delivered a strong turnaround out of the limelight since its previously hefty pension deficit, as well as debts of £170m, left it looking decidedly wobbly in 2008.

Johnson Service provided further evidence of its rebound yesterday. Its three divisions all grew their bottom line, which resulted in a 5 per cent rise in pre-tax profits to £6.5m for the half-year to 30 June.

While its facilities management division enjoyed an uplift from new contract wins, the dry-cleaning arm – best-known for its Johnson Cleaners presence on the high street – benefited from "considerable" investment and grew revenues despite the challenging conditions for consumers.

More importantly, the group slashed its pension deficit to £3.2m from £11.2m last year, while a more modest reduction in its net debt leaves it only £51m in the black. Investors also toasted a 22 per cent rise in its interim dividend to 0.33p. Bolstering the investment case is the thin valuation, with Johnson trading on a modest forward earnings multiple of 6.8 times.

SQS Software Quality Systems

Our view: Buy

Share price: 175p (-19p)

We bought SQS in September, when shares in the software-testing firm were changing hands at 179p. Until Monday, they were doing all right, and closed at 194p at the start of the week. But yesterday's half-yearly results left them sitting at 175p last night. The weakness was pinned not so much on the figures, but on the gloomy outlook.

SQS said that the clouds gathering over the global economy meant that it now expected revenues to remain flat in the second half of the year, and "consequently expect profits to be at the lower end of expectations".

Although far from cheery, the statement was not so negative as to warrant a nearly 10 per cent decline in the share price. In fact, given the company's continued investment in its management services business, and the fact that its shares trade on around eight times forward earnings, we think a rebound is on the cards.

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