Investment Column: Cash-generative Croda has an air of beauty

Balfour Beatty; Wetherspoon (JD)


Our view: Buy

Share price: 550p (+22p)

Investors feeling browbeaten by the steady stream of profits warnings and cautious market updates should read through yesterday's third-quarter trading update from the speciality chemicals group Croda. Then they should call their broker and buy the shares.

The company reported consensus-busting numbers, saying pre-tax profits for the period were up 73 per cent to £24.6m and it was confident about the rest of 2008 and 2009 as well. The group supplies most of the world's major cosmetics companies with ingredients for things like shampoos, soaps and beauty products, which is key, says chief executive Mike Humphrey, as the most robust markets of all are "age and vanity".

Punters may be slightly concerned the shares were up only 4.2 per cent, suggesting the market may have priced the results in. But the analysts were keen to recommend the stock. Those at Citigroup said that, trading on a 2009 price-earnings ratio of 14 times, "the shares remain somewhat undervalued."

There is a concern about the rising costs of raw materials, which Mr Humphrey says he has been passing on for the past eight quarters. There is resistance from customers, he concedes, but "if a speciality chemicals company does not have pricing power, it is not a speciality chemicals company". Most of the watchers reckon the share price will head towards £7 in the next year and, combined with the numbers, the undervalued stock and the cash-generative nature of the company, Croda should be a banker for investors.

The group has US dollar-denominated debt, which has become more expensive in recent weeks as the dollar has strengthened, but that should not stop investors buying a defensive company with genuine growth potential in the next 12 months. Buy.

Balfour Beatty

Our view: Buy

Share price: 293p (+25.25p)

The engineering and construction group Balfour Beatty spends 76 per cent of its time working on public sector projects, says UBS. Ordinarily, this might not be seen as particularly interesting: predictable earnings, a solid order book, et cetera.

Companies such as this, however, are now the belle of the ball for investors. As the economic downturn starts to bite, buyers will increasingly move to perceived safe havens such as Balfour Beatty as a place to park their cash. The group said in a trading statement yesterday that cash generation and trading had been strong between June and the start of this month, adding that the confirmed order book was in better shape than when the company last updated the market.

The group's shares rose 9.4 per cent, and analysts are confident there is more to come. Those at Numis argue: "Our detailed breakdown of Balfour Beatty's operations, outlook and strategy points to the group showing sustainable double-digit growth based on the interaction of these factors." They add: "Our target price of 507p gives us some 45 per cent upside, based on a combined services price-earnings ratio of 10 times and PFI equity on 6 per cent discount rate. We believe that neither is demanding, given the group's dominant position in most of its major product and geographic markets."

If there is a fly in the Balfour Beatty ointment, it is that the shares have fallen by more than 30 per cent in the last quarter, a rate not dissimilar to the rest of the market. This would suggest that, hitherto, the market has not seen the group as that different from the rest of the construction sector. The chief executive, Ian Tyler, argues that the market has ignored individual stocks in recent weeks and that before long investors will start looking for potential in oversold shares. We tend to agree. Buy.

Wetherspoon (JD)

Our view: Sell

Share price: 273.5p (+26.5p)

Wetherspoon, the budget pub chain, announced a surprise yesterday, saying that like-for-like sales in the last quarter were up 1.5 per cent, arguably as drinkers leave their own local and head for a cheaper pint elsewhere. The stock jumped by 10.7 per cent.

However, that might be the last bit of cheer for some time, according to analysts at Evolution who predict the stock will fall to 170p. They argue: "There is still little clarity on how it will fund the $140m [£87m] US private placement due September 2009. If the debt is to be repaid out of cash flow, it will need to cut the dividend and cut back the [capital spending] programme. Wetherspoon is one of the most shorted stocks and we would expect the shares to rally in the short term." Wetherspoon said yesterday it was considering repaying the entire debt, rather than risking an expensive refinancing.

Trading on a price-earnings ratio of 9.9 times, Wetherspoon shares are the most expensive in the licensed retail sector, says Evolution. Sell.

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