Shift in balance pays off at GKN
THE INVESTMENT COLUMN
The results, way above expectations of pounds 130m, reflected strong trading across the group. The company's attempt to rebalance itself away from the cyclical swings of the automotive industry are clearly starting to pay off. Improvements in production costs and growing volumes are driving margins up.
Westland, the helicopter business bought last year, was consolidated for the first time, and try as the suspicious did to uncover some accounting trickery, the deal looks clean. After securing a pounds 500m order from the RAF in March, Westland went on to win a slice of last month's pounds 2.5bn attack helicopter contract for the army. Both orders will ensure rising profits in the aerospace and military vehicles business.
Automotive operations continued to produce the lion's share of sales and profits. Sales of pounds 1.1bn were up a fifth and contributed almost two- thirds of the group figure of pounds 1.67bn. Buoyant car sales in North America and improving conditions in Europe pushed pre-tax profits from these operations up 49 per cent to pounds 106m.
The question now exercising analysts is just how sustainable this sort of profits growth is. GKN's success is not all about cost control and sound management; operations, particularly the automotive business, have been riding in the slipstream of recovery in Europe and America. Both these markets are expected to slow over the next year or so but there are still good reasons to remain positive on the stock.
Recent contracts in the booming light truck market should ensure some protection against any slowdown in the car market. Chep - the world's leading pallet hire service - also has further to go on both sides of the Atlantic. In America, Chep is just starting up while in Europe good penetration of the German market bodes well for the future. Volume is being added at a significant rate, and profits should flow through strongly now break-even has been reached. Profits from the Warrior armoured vehicle contract with Kuwait, which have only started to trickle through, could be substantial.
In the context of such buoyant profits growth, a 9 per cent rise in the dividend to 8.75p is arguably a little stingy, but increasing cover can also be seen as a virtue in the long run. Analysts yesterday upgraded GKN's full-year profits from pounds 270m to around pounds 305m. That puts the company on a forward rating of 14.7, not expensive given the growth prospects.
Reed-Elsevier's first-half figures prove yet again that the Anglo- Dutch publishing company is in safe hands. Recent acquisitions have tended to be earnings-enhancing; margins remain robust in the key scientific and professional publishing sectors; and the company has sensibly put its lower-margin consumer books and regional newspapers up for sale, to concentrate on the creation and distribution of what it calls "must-have" information.
Indeed, so safe are the hands that the market shrugged off a rise in operating profits of 18 per cent to pounds 270m, at the top end of analysts' predictions, leaving the shares unchanged at 942p.
The key factor behind the higher-than-expected earnings was US electronic publisher Lexis-Nexis, whose underlying performance exceeded management forecasts comfortably. Indeed, operating profits were up a whopping 74 per cent for professional publishing, which included a contribution of pounds 40m from Nexis-Lexis.
A word of warning, however. That included some tax accounting twists and won't be sustainable into the next half because of anticipated higher expenditure for new product development. There were one or two other worry spots in the otherwise pristine set of figures.
The travel operations, which include hotel directories and airline reservation systems, had a difficult six months. Moreover, the consumer books division, which is up for sale, shared the general misery of the industry, although Reed did rather better than some publishers, notably Harper Collins, part of Rupert Murdoch's News Corporation, and Penguin, a Pearson subsidiary.
The benefit of selling low-margin assets is made crystal clear in these figures. Operating margins in the six-month period were a smidgen over 23 per cent. But stripping out the assets Reed intends to sell, margins jumped to 25.8 per cent.
As the disposal programme gathers steam, it is becoming increasingly clear that early estimates of proceeds up to pounds 1bn look far too optimistic; pounds 700-pounds 800m may be a more realistic goal. The company won't say what it expects to receive, but concedes that in the regional newspaper market at least, there are probably more sellers than buyers. Still, even pounds 700m invested in higher-margin assets will do much for the company's fortunes.
Getting rid of the surplus assets is likely to take as much as a year or even 18 months to complete. In the meantime, with analysts expecting full-year earnings of pounds 700m, rising to pounds 790m in 1996, the shares - trading on a forward multiple of more than 16 - look fully valued for now.
Few risks at Willis Corroon
Having got Willis Corroon so wrong 18 months ago, when the shares collapsed as the extent of the company's bloated cost base became apparent, the market is approaching the insurance broker's shares with circumspection. Maybe too much so - overheads now seem to be under control, the sales line is behaving better than sceptics feared, and the shares are looking better value than for some time.
Interim figures yesterday, showing pre-tax profits up 23 per cent to pounds 66.3m, were well received by analysts but the shares still slipped 1p to 147p as investors held back from falling completely for the company's bullish line.
The fact is that trading conditions remain extremely tough, with premium rates falling in both the US and the UK. All the profits rise came from the continuing benefit of the cost-cutting programme started last year and well on track to secure at least pounds 26m of savings by the end of the year.
One of the main planks of the bear case for Willis was the worry that cutting staff - over 800 have gone in the past year - would lead to a sharp fall in sales volumes. In fact, retail turnover in both the UK and the US rose by 2 per cent during the half-year.
There have also been a flood of scare stories about premium rates in the UK falling by between 10 and 20 per cent. In practice, the effect of the falls has been mitigated by a higher level of fee-based work, which is not affected by declining commissions.
Because Willis Corroon is undergoing such a sharp recovery, valuing the company on traditional earnings measures makes little sense until next year. On the basis of forecast profits of pounds 101.5m in 1996, and earnings of 15p, the shares currently trade on a p/e of under 10.
The decline of insurance broking, as direct sales and self-insurance become more widespread, means a p/e discount is appropriate, but even rating the shares 15 per cent less than the rest of the market implies a share price of 165p. A prospective yield next year of almost 6 per cent underpins the shares.
Turnover pounds P/Tax pounds EPS Dividend
Bostrom (I) 38.7m(32.4m) 2.55m(2.25m) 10.4p (10.1p) 2.7p(2.5p)
Edinburgh Oil & Gas (I) 1.5m(886,000) 378,000(-60,000) 1.08p (-0.22p) -(-)
Games Workshop (F) 32.1m(24.5m) 6m(4.65m) 13.1p (10.6p) 3.7p(-)
GKN (I) 1.67bn(1.52bn) 162.6m(97.3m) 28.1p (16.6p) 8.75p(8p)
Reed Elsevier (I) 1.81bn(1.51bn) 370m(332m) 26.3p (23.6p)* 7.5p(6.7p)*
Royal Insurance (I) -(-) 241m(191m) 29.3p (27.9p) 5p(4p)
Westminster Health Care (F) 69.5m(50.4m) 13.8m(11.2m) 22.5p (18.7p) 3.3p(2.75p)
Willis Corroon (I) -(-) 66.3m(54.1m) 9.7p (7.8p) 3.3p(3.3p)
(Q) - Quarterly (F) - Final (I) - Interim *per Reed Interational share
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