The Investment Column: Pennon provides a safe place to hide in slowdown

BPP Holdings; Rok
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The Independent Online

Our view: Buy

Share price: 629p (-14p)

The water companies have a habit of annoying consumers. The usual gripe, often involving allegations of fat-cattery, is that prices rise before services improve.

The latest of these arguments surfaced on Monday when the companies submitted business plans to Ofwat for the five years starting in 2010. Pennon, which owns South West Water, asked for permission to put up prices by 7.4 per cent over the period. While customers may complain, on the evidence of the stock's recent performance, investors will be grateful that they have shares in the company. Unlike most in the FTSE 250, Pennon's share price is up, by 8.7 per cent, over the 12 months, with the group providing a haven for buyers in troubled times.

However, potential buyers thinking that it does not really matter which water group gets their cash should note that the company has not been implicated in controversy regarded misstatements on leakages, and importantly the group has an additional string to its bow, namely its waste division, Viridor. With energy recapture increasingly on the agenda, the move away from landfill being encouraged and an ever greater emphasis on recycling, Pennon is getting lots of incentives to develop the waste side of the company.

The group yesterday issued a brief trading update, which essentially said that everything is fine. The analysts were more upbeat, with Morgan Stanley arguing that Pennon has the "best equity growth in its regulated business of all the listed [water companies]." Those at Credit Suisse were equally lavish, saying that "thanks to a conservative dividend payout policy and investment opportunities in waste, the yield on the stock is low relative to peers (at 3.3 per cent on a one-year forward basis). We see scope for the payout to be rebased upwards by about 15 per cent at the next price review."

Trading close to its year highs and at a price earnings ratio of 17.4 times, the stock is not cheap, and potentially has little room for improvement. However, at the very worst Pennon is a safe place to hide during the financial slowdown. Buy.

BPP Holdings

Our view: Buy

Share price: 423p (+8p)

If you are an analyst, accountant or lawyer, the chances are that at least some of your training has been done with BPP, Europe's biggest provider of professional courses. The group's interim results published yesterday suggest that it is a lucrative business too, with pre-tax profits hitting £9.7m, compared with £8.8m in the same period last year.

It may seem reasonable to assume that a company providing training courses to the financial services industry, and the sectors that depend on it, may be feeling the pinch: as banks become less profitable, so they are less likely to send juniors on courses. The group provides lawyer training and as the firms cut back on hiring, so fewer people will take up places on what are already pretty expensive sessions.

That is the theory. According to the chief executive, Roger Siddle, it is not the reality, with demand for its law courses outstripping supply and people worried about their current jobs training to do something more secure.

According to watchers, however, the market does have the perception that BPP is inextricably linked to financial services.

"The rating on the stock reflects perceptions of greater cyclicality than appears to be the case and the weakness of the small/mid-cap sector. We believe the shares offer significant upside potential given the low rating, high ROCE, leading market positions and growth outlook," say those at Panmure Gordon.

Another plus for investors is that because of this low rating, private equity groups cannot be too far off the scent. Mr Siddle denies any contact with financial sponsors, but the group looks prime for a buyout. Investors should get there first. Buy.


Our view: Cautious hold

Share price: 98p (-7p)

Being labelled a construction company is a shame for Rok, especially as it is doing everything it can to get out of building anything other than social housing. Indeed, the group announced yesterday, along with impressive interim results, that it is closing its commercial property arm, which was seen by the market as a radical but welcomed move.

The group posted notable pre-tax profits numbers, showing a climb of 22 per cent. However, the chief executive, Garvis Snook, reckons that a recession is inevitable, which is one of the things that led watchers at Panmure Gordon to suggest that the share price will be "treading water for a while". Mr Snook, however, reckons that the slowdown will be a good thing after the market got ahead of itself in the last few years.

Indeed, despite Rok's exposure to the construction sector, the Panmure Gordon watchers say that the stock will reach 120p and that clients should buy.

The shares have risen by about 50 per cent in the last month, but trading at 8.5 times 2008 estimated earnings, when the rest of the sector is on seven times, Rok is already pricey, irrespective of its more defensive qualities. There will be a time to buy Rok, but it is not when the economy is heading into recession.