Investment Column: Whitbread's calmed City's nerves, so buy

Northern Foods; Scottish & Southern Energy

Our view: buy

Share price: 1407p (+22p)

Whitbread responded to a mounting of City rumours of a cash call by saying yesterday that it had "no current intention" of launching a £100m rights issue. But the owner of Costa Coffee and Premier Inn budget hotels reiterated that it was considering diversifying the sources and tenure of its debt by borrowing more through the capital markets.

That should calm nerves, for now at least. After all, Whitbread has been one of the leisure sector's strongest performers during the recession and appears to have genuine momentum.

The was evident from a 6.6 per cent rise in underlying profits to £239.1m for the 12 months to 4 March, which came despite Whitbread facing strong recessionary headwinds. In particular, its Premier Inn chain suffered a 6.4 per cent fall in revenue per available room, a key measure for the hotel sector, as businessmen and women cut back on overnight stays.

But Whitbread fought back last year with a promotional campaign targeting weekend leisure customers and outperformed the market. The group, which also runs Brewers Fayre and Taybarns restaurants, is to invest an additional £8m in marketing its hotel and restaurants this financial year, alongside a further expansion in the Premier Inn estate. Costa Coffee, which has delivered 32 consecutive quarters of underlying sales growth, also plans to grow from 1,600 shops worldwide to 3,000 outlets by 2014-15.

Furthermore, prospective share buyers may note that Whitbread's stock has fallen back recently, partly because of profit-taking by investors, since hitting a 12-month high of £16.31 on 26 April. The shares now trade on a 2011 forecast multiple of 13, which is a significant discount to rivals including InterContinental Hotels.

While Whitbread could be hit by a relapse in spending by consumers and businesses, we think it is over the worst and its shares offer good value compared to rivals, so buy.

Northern Foods

Our view: Hold

Share price: 46.75p (-1.5p)

Northern Foods is to invest an extra £5m in relaunching its Goodfella's pizza brand this year with its advertisement campaign starring a pizza fairy. Northern, which supplies the big four supermarkets and Marks & Spencer, hopes that the character – a waiter with wings and a wand – will work magic on a tired pizza brand in what it expects to remain a "tough market".

However, the costs of the campaign will weigh on the company's first-half profits. In the previous year to 3 April, Northern Foods delivered flat underlying pre-tax profit of £39.2m, although its performance was a shade above expectations in the City. It further gave the impression of running fast to standstill by posting total sales up only marginally at £977m. While Northern Foods cooked up strong sales at its chilled business and bakery division, they fell at its frozen division, largely as a result of it closing a low-margin pizza factory.

However, there was plenty to recommend in the results. For instance, Northern Foods reduced its net debt to £183m, maintained the dividend and improved its operating margin by 0.2 per cent to 5.6 per cent. Investors may also chew over the fact that its shares, which now trade on a 2011 price-to-earnings ratio of 7.2, are starting to look cheap. However, given the tough outlook for the grocery sector and consumers, we think next year may be a better time to start tucking into Northern Foods, so hold.

Scottish & Southern Energy

Our view: Buy

Share price: 1079p (-27p)

The markets like certainty above all things, and that's exactly what Scottish and Southern Energy delivered when it said that, though it was still interested in the sale of EDF's UK electricity distribution business (and may take a stake), it will not wade in so deep as to necessitate a rights issue.

We usually wait a few months before revisiting our recommendations, but SSE's disclosure means that we can no longer justify the hold rating issued last month. At the time, we voiced fears that the shares could be hampered by the threat of a cash call, even though SSE's dividend policy could pay handsomely if retail price inflation continues to advance at current rates

With the cash call fears dealt with, we now think investors should move in, particularly in light of the increasingly volatile conditions across the capital markets. Utilities such as SSE, which trades on fairly undemanding valuation multiples of less than 10 times forward earnings, tend to benefit during times of economic stress as traders move their money from riskier areas such as finance to defensive sectors such as power and energy. That being the case, we now say buy.

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