Investment Column: Time to recycle profits from Pennon punt

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The Independent Online


Our view: Take Profits

Share price: 540p (+8p)

So South West Water's owner, Pennon, has accepted Ofwat's ruling on what it can charge for the next five years. Now there's a surprise. The settlement has been described by the company as "tough", requiring a £1 real-term cut in bills by 2015. South West had asked for a £5 rise but, given that Ofwat's draft ruling had called for a rather more substantial cut in real terms, it could have been a lot worse.

An appeal to the Competition Commission would have been costly as well as time consuming, with no guarantee of success – not least because South West is already Britain's most expensive water company and the energy regulator imposed a tougher settlement (in terms of cost of capital) on its charges. The rise in Pennon shares on the back of yesterday's announcement tells its own story. Pennon has made the right call.

But what does this mean for the shares in the longer term? Again, it is not all that bad. South West is going to have to run faster just to stand still and retain its position as the group's cash cow. That means cutting costs.

But Pennon also has Viridor, the waste management company, which operates in a growing market and is doing well. It should allow the firm to maintain an admirably progressive dividend policy, whereby the payment will be increased at above the rate of inflation through to 2015.

Pennon therefore has a lot to recommend it. We said buy at 481.25p when the economic environment was less optimistic, and Pennon's attractions as a defensive play were obvious. The shares have done us proud since then. However, while a yield approaching 4.2 per cent and a growing dividend is attractive, the shares are now starting to look on the expensive side, with a prospective multiple of 15.6 times full-year forecast earnings. Pennon is a solid operation, but now looks to be a good time to book some of the gains made on this stock and recycle them into something a little more racy. So take profits.

Capital and Regional

Our view: Buy

Share price: 39p (+0.25p)

Although it's not exactly boom time, the stock market is getting stronger by the day, forecasters expect next week's official figures to show Britain is out of recession, and commercial property values are ticking higher after a lengthy period in the doldrums. Yet despite this improving outlook, shares in Capital and Regional, the specialist property investment company, remain becalmed.

While there have been signs of life in recent weeks, the stock trades on an 11 per cent discount to estimated net asset values for 2009. But that gap widens to a yawning chasm – 38 per cent – when set against the estimates that Evolution Securities has come up with for 2011. That's an enormous discount and suggests there is some real value to be had in these shares.

In its post-close trading update yesterday, Capital and Regional said that, in keeping with the broader strength in investment markets, the valuation of each of its UK funds improved in the fourth quarter of 2009. The Junction Fund, for instance, saw its property values rise by 10.6 per cent. Adjusting for a recent disposal, that is some 8 per cent ahead of Evolution's estimates.

The company said that its tenant markets continued to pick up in the fourth quarter, with collection levels improving, the number of tenants in administration falling and occupancy levels remaining stable.

The German portfolio's defensive characteristics remain evident – both occupancy and collection rates, for example, sustained the high levels seen in previous quarters. All this suggests that the shares should do much more than hold their own. Buy.


Our view: Speculative buy

Share price: 18p (+1.5p)

What's in a name? Apparently quite a bit. 3Red had a rotten first half (revenues declined 11 per cent) but a storming second half (up 18 per cent). Interestingly, the revival dates to the August withdrawal of the 3Vegas casino brand by William Hill after 3Red enlisted the help of m'learned friends. As a result the gross win in 2009 of £12.8m is down by just 1.6 per cent, which isn't bad given the economic outlook all gambling operators have had to deal with.

The difficulty for 3Red – which, ironically, the William Hill issue rather demonstrates – is that it is something of a small fry in a pool of sharks. But the 2010 outlook statement looks positive and, with net cash in hand (£1.4m), the company has the opportunity to address this strategic bind. So 3Red is on 10 times forecast 2009 full-year earnings falling to 8.8 this year and faces risks as a smaller player. But the shares are in a bit of a trough, so they might be worth a speculative punt for those with an appetite for risk.