Investment Column: Telecity's record justifies continued faith

Smurfit Kappa; CSR
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The Independent Online

Our view: Hold

Share price: 489.7p (-4.3p)

The data centre operator Telecity unveiled a solid set of results yesterday. Revenue grew 16 per cent to £196.4m while adjusted profits before tax grew by a healthy 45 per cent to £51.4m. Despite this the shares fell.

Why? Well, the company has been the beneficiary of a very good run, and clearly some of its investors decided to take profits. They also worry that growth is set to slow and have come to the decision that it's time to cash in.

Should we follow their lead?

There is no doubt that there is a strong demand for Telecity's services, and that demand is growing. But Altium Securities has neatly illustrated why some investors may be heading for the exit despite what appear to be strong prospects for further growth at the company.

Altium points out that data centre companies effectively have three levers with which they can drive revenue growth: they can expand capacity, increase the utilisation of what they already have, and, finally, put up prices. Telecity's total announced capacity grew 60 per cent last year, but 90 per cent of that will not open until the second half of this year. As such, Telecity grew last year and can carry on growing, but it just might not be as stellar as it has been. Utilisation rates are already high and the ability of the company to impose double-digit price rises is coming to an end. Mid single digit is more likely.

Growth could accelerate next year, as new capacity comes on stream, but Telecity is certainly going to find the going tougher. All the same, it has played a good game so far, and bid rumours continue to circulate, which should at least provide a floor for the share price. We said "hold" at 435p last August, and the shares have done well. There is an argument for taking profits but on balance, despite a pricey rating of 22 times next year's earnings, we'd keep holding for the moment.

Smurfit Kappa

Our view: Take Profits

Share price: €8.6 (-0.41c)

Paper-based packaging might not be sexy, but the market leader, Smurfit Kappa, has been a good earner over the past 12 months. When we looked at the stock in January 2010 there were still risks associated with buying into a company that recorded a €52m (£44m) loss and a revenue slump of 14 per cent the year before. We thought the risks worthwhile, and we were right: canny buyers have seen their investment grow by a third.

Yesterday's full-year results from the group showed a tasty 53 per cent profits rise on revenues up by a healthy 10 per cent. And with earnings before interest, taxes, deductions and amortisation up 22 per cent, the group's leverage dropped to around 3.4 times, from 4.1 at the end of the previous year. All further good news.

The bogeyman in all this is commodity prices. Smurfit Kappa is already feeling pressure on its margins from hikes in raw material costs, from wood to energy. And although the management are confident they can put up prices again in the first quarter without hitting demand, we are not convinced it is worth the risk. For those keen to hang on, the potential for consolidation across the global packaging industry later this year is a temptation. But we would prefer to quit while we're ahead.

CSR

Our view: Buy

Share price: 445.3p (+37.8p)

Anyone harbouring even the faintest doubt about the strength of CSR's results need only look at the chip maker's stellar share price. The stock bounced yesterday as the market cheered the news that the firm had booked $184.8m in fourth-quarter revenues, comfortably surpassing the expected $178.5m. Earnings per share were also higher than forecast, coming in at 7 cents, against City predictions of nearer 6 cents.

More pertinent from an investment view were comments by CSR's chief executive, Joep van Beurden, who said that while the business was "under exposed" in the fast-growing smartphone market, and although it was likely to remain so for a "couple more quarters", it had a "clear plan in place to turn that around". This is encouraging, and bodes well for the company's longer-term prospects.

The shares also remain attractively priced. In terms of enterprise value to earnings before interest, tax and amortisation, CSR is on just 7 times forward earnings for 2011. That leaves it at a discount to the wider semiconductor sector, something that should begin to change in the wake of last night's results. Buy.

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