Investment Column: Sterling's slump adds to Wolseley's woes

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The Independent Online


Our view: Sell

Share price: 201p (-85p)

Things are going from bad to worse in the housebuilding and construction industries. The British plumbing and heating supplies group Wolseley said yesterday that its half-year profit would more than halve as housing markets continue to slow. But Wolseley, which holds a substantial part of its debt in euros, has also been hit by the weakness of the pound. In the final five months of 2008 its net debt increased by about 20 per cent to £3bn, largely due to a £557m hit it took on exchange rate movements. Trading profit was down by 80 per cent in the UK, 60 per cent in Europe and 16 per cent in North America, while overall pre-tax profit fell by 66 per cent year on year.

Shares in Wolseley tumbled by 29.7 per cent yesterday, with the company warning that until consumer confidence returns and availability of finance for customers improves, it expects its performance to decline further.

There is further bad news for investors: with its stock still trading at around six times forecast earnings despite its recent falls, the building materials company remains more expensive than its more UK-focused rival Travis Perkins, which trades at just over twice forecast profit.

Yesterday's announcement had analysts at Numis saying that trading is "much worse than we expected and a higher level of net debt now seems to make [a] covenant breach inevitable at year end July 2009". Those at Collins Stewart reckon that a rights issue is equally inevitable. Both would be bad news for existing shareholders. Sell.

WH Smith

Our view: Hold

Share price: 350.25p (-4.75p)

Against the widespread carnage on the high street, WH Smith's recent performance – depressed but in line with expectations – has much to recommend it. Although not good enough for a buy, it is not deserving of the sell, sell, sell levied at many of its retail peers.

According to yesterday's trading update, overall like-for-like sales were down 5 per cent for the 20 weeks to 17 January, with high street sales falling 7 per cent, the entertainment business down 3 per cent, and travel, the stellar performer, down just 1 per cent.

Among all the falls, gross margins are a ray of sunshine. In both the high street and travel businesses (which runs outlets at airports and railway stations), margins are improved. And the five-year revival strategy, launched in 2005, has gone some way to cut WH Smith's reliance on the CD and DVD markets – which will also have helped to insulate it from the collapse of Woolworth's EUK business late last year.

City analysts are still maintaining full-year pre-tax profits estimates of around £79m for the year to August, and the group's price-earnings ratio of 9.2 is at a 10 per cent discount to the sector average. With margins improving and the chain's low-price products likely to hold up better than rivals' in a climate of reduced consumer spending, WH Smith is worth hanging on to, even if the shares did drop 1.34 per cent on yesterday's news. Strong cash generation and a robust balance sheet are also in its favour. Hold.

AT Communications Group

Our view: Hold

Share price: 14.25p (+1.75p)

AT Communications (ATC) describes itself as an "ICT company focused on the delivery of IP-based solutions and services to small, medium, and large enterprises". Translation: It provides IT and telecoms systems for businesses, with the chief executive, Alex Tupman, calling it a "small BT". The most lucrative bit is servicing these contracts, and the group has been expanding further into the managed service business to help boost margins.

The shares have taken a bit of a hammering since the summer; disappointing for a company in a sector that tends to be relatively resilient to a downturn. The shares were up 14 per cent yesterday, however, after a trading update forecast turnover and earnings before interest, taxation, depreciation and amortisation would hit expectations for the full year. The market had feared ATC would miss its targets.

There was good news related to the company's worrying level of debt. The group announced it had paid down £4m since June, cutting borrowings to £18m. The group is also working on a disposal "which will go a long way to reducing debt levels".

ATC also revealed interest in one of its subsidiaries, and a new three-year contract with BT to provide sales services. The house broker, Cenkos, said that trading on 1.5 times this year's earnings prices the company as a distressed asset, but yesterday's announcement should help to kick-start a re-rating. There might well be some upside, but that debt has to come down further, and we want a bit more clarity over the future. Hold.