Investment Column: Severn Trent may be a rare rose in winter
PZ Cussons; Porvair
Wednesday 27 January 2010
Our view: Buy
Share price: 1141p (+4p)
Phew. What a long, tempestuous, haul it was for water companies as the regulator Ofwat drafted and re-drafted its price determinations for the next five years. Now the dust is finally starting to settle.
Yesterday, Severn Trent issued a management statement for the four months from October to January, confirming that trading was in line with expectations. The declines in demand recorded last year during the recession are beginning to stabilise, and the year-on-year drop in revenues is now expected to be between £5m and £10m, rather than the £15m to £20m that was originally forecast.
Everything else remains much as it was, with bad debts at about 2.3 per cent of turnover, and capital expenditure for the year to be £610m to £630m. The even bigger issue for the stock is last week's decision to accept the Ofwat price ruling published in November, rather than appeal to the Competition Commission.
In fact, the watchdog finally agreed a less punitive settlement than that it originally put forward, but it was still sufficiently testing for watchers to be predicting rights issues and a 20 per cent re-basing of the dividend. Except that Severn Trent's chief executive, Tony Wray, has now confirmed that has no plans for a rights issue, although it is cutting the dividend by 10 per cent.
Overall, the water sector underperformed last year, even as a low-yield, safety investment, because of the uncertainty of the price determination. Severn was more oversold than most. With the future now certain, the only cloud over Severn's immediate future is the cost of bringing leakage rates back down after the frost damage caused by the recent cold snap.
But most analysts think it is a risk worth taking. Ed Woolfitt, the head of trading at Galvan Research, said that unless the extreme winter made leakage levels even wrose, Severn Trent shares, which trade at about 1.5 times next year's earnings and yield more than 5 per cent, could be expected "to progress steadily higher". Generally we are bearish about the water sector, but Severn Trent could be a rose among thorns. Buy.
Our view: Buy
Share price: 250p (+3p)
Cussons has been a real star for this column. When we last said "buy" in June, it stood at 182.5p. Since then, its shares have soared. Over the past year they have shot up 67 per cent, outperforming a 28 per cent rise in the FTSE All Share Index. That makes it looks like a technology superstar, but PZ is best known for making soap and shampoo. Perhaps there's something in this idea of running a company well and steering clear of too much debt.
Yesterday's numbers were ahead of expectations, with pre-tax profits up 21 per cent at £44.7m, and things look to be going in the right direction. We wouldn't be too worried about acquisition talk – adding new brands and improving geographic spread beyond the core markets of the UK, Indonesia, Australia and Nigeria looks sensible to us.
Time to take profits then? Maybe not. The shares trade on just under nine times next year's forecast earnings, which in global terms makes the company looks relatively cheap. While Britain looks torpid economically, the levels of world growth forecast should help PZ Cussons's sales. This year, its revenue increased by 0.7 per cent to £370m. The share price increase has slowed recently, but with a rising dividend and cash in the bank there is arguably more to come, so keep buying.
Our view: Hold
Share price: 55.5p (-4.5p)
Porvair, which designs and manufactures specialist filters for a variety of industries, yesterday reported a disappointing £1.7m in full-year profits before tax and one-offs, down from £4.2m in 2008. However given the economic slump, the decline in profitability in the 12 months to the end of November is perhaps unsurprising.
The key drag was Porvair's metals filtration division, which took a hit in the first half of the year as destocking in the aluminium and the US automotive markets sapped demand.
That was then, though. The business has since picked up the pace. The £1.7m in profit was almost entirely generated in the second half, as the benefits of the company's moves to reduce its costs coincided with the passing of the worst of the global recession. And though the overall economic picture remains fragile, conditions in Porvair's end markets seem set to improve further.
The valuation makes us pause a bit. Porvair trades on a steep multiple of 20.9 times Altium's forecasts for 2010. That said, the shares are off their highs, and the company's earnings could recover quickly. There's enough here to make Porvair worth holding.
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