Investment Column: Drax shares continue to suffer, so get out
SSL International; Range Resources
Wednesday 19 May 2010
Our view: Avoid
Share price: 334.1p (+4.4p)
We have been rather dubious about shares in Drax Group, the power station company, for some time.
It is not that we think that there is anything wrong with the business, its growth prospects or its management. In fact, we think that all of the above are in good order.
The thing that worries us about investing in Drax is the share price that continually underperforms. Last October, we said buy, not because we thought that the shares would suddenly start doing well, but because of the group's 7 per cent dividend yield.
The shares have continued to fall, dropping by more than 25 per cent in the last six months alone. Of course, the yield has not come to any harm with the poor share price performance, but all this comes at a time when most other leading stocks are flying.
Tony Quinlan, Drax's finance director, says that the stock is a complicated one for "unsophisticated investors". We would argue that even the sophisticated ones struggle as well.
And yet, the news from Drax continues to be good. Yesterday, the company issued an interim management statement saying that "the commodity markets in which we operate have remained challenging," and the shares improved slightly as the group added that it was nonetheless benefiting from a strong contractual position and that it was trading in line with its own expectation.
The company argues that the share price is held to ransom by the "dark green spread", which is related to power prices. The market is king however, and while we continue to think that Drax is rather well set up, it seems to have little support among investors for now.
There may be investors that think it's a bargain, and it is certainly true that the shares are inexpensive at their current value. The group is also doing interesting work with biomass power. This will take some time to come online, however, and we would now wait for an improvement in the share price. Avoid.
Our view: Buy
Share price: 818.5p (-6.5p)
We've been fans of SSL International for some time now. Though we've stopped short of buying the shares – more on that later – we've always thought this a well-run company. The group, which makes Durex branded condoms and Scholl footwear products, confirmed our faith with yesterday's full-year figures, with sales rising by 25 per cent and operating profits jumping by 41 per cent.
The Durex Play range of sex toys and lubricants continues to find favour with punters, most notably in Spain.
Clearly we're not about to sell SSL. The last time we looked at the stock, however, we held back from buying owing to the valuation. The shares, partly driven by bid talk, had got ahead of themselves.
So is it worth it buying now? Well, it still can't be characterised as cheap. SSL is trading on a multiple of 21 times price to 2010 forecast earnings, according to Evolution Securities, whose analysts suspect that "many shareholders are waiting for a potential takeover".
Applying the metric of enterprise value to earnings before interest, tax, depreciation and amortisation, the stock ends up on a multiple of 12.7 times on Panmure Gordon's numbers for this year, and on 11.8 times on the broker's numbers for next year. That puts SSL about 10 per cent ahead of its peers.
The question, then, is whether this premium is justified. Given the uncertain economic picture, and increasingly volatile market backdrop, we think it is. Investors are jittery and the more they worry, the more likely that they will move to consistent performers like SSL, whose products, let's be frank, are unlikely to go out of fashion anytime soon. Buy.
Our view: Buy
Share price: 3.75p (-0.38p)
Range Resources, it must be said, is at the extreme end of the risky investment spectrum.
The group updated the market yesterday on the progress of a well it is drilling in Texas, which is all part of its attempt to lessen the risk for potential backers. That is, of course, because its primary activity so far has been centred on its assets in northern Somalia, which despite being 1,600km north of the troubled capital, Mogadishu, still gives investors pause for thought.
In fact, Range is a broader company. It is already in production, albeit in modest amounts, in Texas and has another four wells to drill later this year. We reckon the newsflow alone will drive the share price this year.
Range's assets in Somalia could be highly lucrative, and shareholders would have a day to remember if the project holds as much oil as the company hopes. We reckon that the market is yet to price in the project. Buy.
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