Smaller Companies: Don't get sweet on Thorntons

IT HAS been the sweet taste of success for shareholders in Thorntons, the upmarket chocolate retailer and maker, on the progress of the last few years. From a low of 135p in early 1996, the shares have climbed, and now stand at an all-time high of 288.5p.

Not bad, when so many smaller companies have been stuck in the doldrums. Clearly the view is that the nation's sweet tooth is in no danger of disappearing, whatever the verdict of the health police, and that expansion will go on unimpeded for the next few years.

And on their current price, the shares are expecting great things to come. Assuming the company maintains sales growth of 20 per cent a year for the next three years, the shares are still trading on a price/earnings ratio of 23 times for 1998 earnings and 20 times 1999 earnings, on the basis of forecasts by stockbroker Henderson Crosthwaite. That is roughly a 25 per cent premium to the sector. Last October the group posted a 32 per cent rise in profits to pounds 11.5m for the year to June 1997, excluding a pounds 21.7m restructuring provision in 1996.

At the same time recently appointed chief executive Roger Paffard has introduced a simple plan for keeping the ball rolling. He hopes to oversee a huge stores expansion, with 200 new shops opened over the next four years, taking the chain to more than 500 sites. Over 500 staff will be recruited for the expansion.

He also hopes to restructure the manufacturing and packing facilities.

While there should be scope to improve efficiencies, this could well be offset by the cost of the expansion. Rents, pre-opening expenses - refurbishing and fitting out the new shops - could well prove a drag on profits for the next few years. And profits are also dependent on new manufacturing facilities opening in time for this year's Christmas rush. Work is on schedule, but it introduces further uncertainty into the equation.

The market is over-egging the cake at Thorntons. Growth should continue, but the share price is expecting too much. For non-holders the shares are best avoided. Existing holders could be well served by taking some profits.