The Investment Column: Interserve looks tasty as recession fears grow

3i; Big Yellow Group
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The Independent Online

Our view: Buy

Share price: 440p (+13.5p)

Interserve, the outsourcing group, is not the most exciting company given its business, which includes running services for schools, prisons and hospitals. However, outsourcing is one of the few sectors thriving despite the credit crunch. Its government contracts are long term, providing consistent and predictable revenues, while businesses feeling the economic heat are increasingly likely to try to cut costs by contracting out expensive activities.

Adrian Ringrose, chief executive, says that Interserve's exposure to the Middle East is a further attraction. The company, which issued an upbeat management statement yesterday, makes 40 per cent of its earnings from the region, and Mr Ringrose says that this is only going up.

Outsourcing stocks have been buoyed by investors moving out of more dangerous sectors. Even so, the analysts say that there is room for Interserve shares to grow, especially as the stock has fallen from a recent high of 518.5p on 18 April.

However, watchers disagree on what sort of reward buyers can expect. Those at KBC Peel Hunt reckon the shares will hit 500p, saying that on a sum-of-all-parts valuation, 500p implies "that the core operations are trading [below] 8 times [estimated] 2009 earnings," which they say, is attractive.

Panmure Gordon experts are more excited, saying that the stock will increase to 600p in the next year.

The outsourcing sector will be increasingly fought over by investors if the market downturn becomes a full-blown recession, which many are now predicting. Interserve's shares, therefore, at an earnings multiple of just 8 times, compared with the likes of peers Capita and Connaught on 14 times, look very tasty. There is still time for investors to do well from Interserve and, indeed, the rest of the outsourcing sector. Buy.


Our view: Hold for now

Share price: 822p (+28.5p)

The timing was uncanny. Just as commentators started calling private equity bosses the masters of the universe early last year, so the debt markets on which the industry relied imploded, leaving the same buyout industry leaders looking more like minnows than masters.

As one of the few publicly listed private equity groups, 3i perhaps gets scrutinised more than most. Yesterday, the firm did not seem to mind, as it boasted a positive first-quarter management statement, saying that the buyout market was still open and that the group had invested £428m, despite the credit crunch. The company says it has returned 26 per cent on its portfolios.

Moreover, despite dire reports from the lending markets, 3i has continued what it calls sub-€1bn, mid-market deals, unabated at about one a month, with regional European banks still happy to finance transactions. The group's infrastructure business is booming, says a spokesman.

However, the wider market is not listening, he says. The group has historically traded at a premium to its net asset value, £10.86, according to Cazenove. Now that the stock has fallen below that level, it is the time to buy, they reckon, especially as the NAV fails to take account of the £10bn the firm holds in its fund management business.

3i is a strong firm, and investors that buy now and are prepared to wait until the return of happier economic times will surely cash in, even if that time is still some way away.

The immediate problem is that as a financial stock, 3i is getting battered by nervous investors. True, it is not in the same league as the banks, but the herd mentality of the market dictates that 3i will feel the aftershocks. Brave investors should go for it. The rest should wait. Hold for now.

Big Yellow Group

Our view: Cautious hold

Share price: 260p (+11.75p)

The last time this column looked at the storage group Big Yellow, back in November last year, it recommended investors sell at 435p. Sage advice, as it turns out.

The problem at the end of last year was that a slowing housing market was kyboshing confidence in the group: as fewer people moved, so the need for temporary storage evaporated.

What has changed? On the face of things, nothing. The housing market, if anything, is worse, with mortgages harder to come by and the value of property falling. However, the chief executive, Jimmy Gibson, points out that the state of the property market does present opportunities. He says that more people move into rental accommodation during a downturn, and that they need storage space. The group owns freeholds on 90 per cent of its property, and cheaper real-estate prices mean more buying opportunities, says Mr Gibson.

Clearly, Big Yellow trades at a sizeable discount to its net asset value, which was reported at £5.20 at the time of the last annual report. This should encourage some, but the company trades at a discount because the market is nervous, even though the group reported a 7 per cent annual growth in revenues yesterday.

Experts at Citigroup think "it will take a few more quarters of similar statements to give wary investors enough comfort to believe in the relative stability of the cashflow". Agreed. Cautious hold.