S&N stays a step ahead of rivals

The Investment Column
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Scottish & Newcastle has good cause to be delighted by the Government's decision to block the takeover of Carlsberg-Tetley by Bass, its closest brewing rival. If it had been waved through, Bass would have leapfrogged S&N to become the largest brewer in the UK with a market share approaching 40 per cent. More importantly it would have had a brewing stranglehold in certain parts of the country, notably in the Midlands, where it would have controlled almost three-quarters of beer supply.

Without the takeover, the ailing Carlsberg-Tetley is left to limp along on its own. It will probably have to close some of its breweries and certainly have to spend plenty of money to revitalise its brands. The Monopolies & Mergers Commission inquiry has in effect put the company in limbo for the past year and it will take time to put its house in order. Meanwhile, S&N should be able to capitalise on Carlsberg-Tetley's disarray and pick up extra business.

Fortunately, S&N forced through its own blockbuster merger before the arrival of the new Government and what looks like a crackdown on brewing consolidation. Its purchase of Courage in August 1995 has proved a good deal. Brewing profits rose from pounds 121m to pounds 177m last year. Wisely, S&N has chosen to concentrate on profits rather than chase market share. This it has achieved by marketing hard its higher-margin premium brands such as Kronenbourg and Beck's, cutting expenses by pounds 70m a year with the closure of two breweries and the axing of 1,800 staff and pushing through price increases.

S&N's managed pub business is also going great guns, with profits up 12 per cent to pounds 149m in the year as it rapidly rolls out themed pubs such as Chef & Brewer, Rat & Parrot and John Barras. Drink and especially food sales from these new outlets are booming and it plans to spend another pounds 150m this year, up from pounds 116m last time, converting another 200 of its pubs to themed outlets. With all the big pub chains pouring money into their managed estates, there have been worries that returns will start to tail off. But the market still looks far from saturated.

The only real black spot is Center Parcs, its indoor holiday park chain, where profits fell 12 per cent to pounds 72m. S&N was guilty of taking its eye off the ball in continental Europe, where poor economic conditions have dampened demand and attendances have fallen sharply. The jury is still out on whether it can rectify the situation by introducing new facilities, but at least the UK business is showing a marked improvement.

Pre-tax profits, before restructuring costs associated with Courage, rose 21 per cent to pounds 374m for the year to April. Merrill Lynch forecasts current year profits of pounds 423m, putting the shares, down 4.5p at 646.5p, on a prospective p/e ratio of 13. Good value.

Taxing questions before Wednesday

Identifying the UK company shares likely to be hit hardest by Gordon Brown's Budget on Wednesday has been taxing investors' minds for weeks now. The obvious targets of the windfall tax aside, one likely Budget proposal which could have a devastating effect is the widely expected cut, or abolition, of the tax credit on dividends.

Certain high-yielding stocks look vulnerable if Mr Brown cuts the tax credit attached to advance corporation tax, which is currently 20 per cent and could be chopped to 10 per cent. The behaviour of fund managers, many of whom have spent the past few years deserting high-yielding shares, is a guide. With tax credits worth less, institutional pension funds, which can reclaim the tax credits on dividends, have less incentive to invest in high-yielding stocks simply for their dividend income.

This is less of an issue for companies with high-yielding shares which can afford to make up the difference by hiking their dividend payout. But weaker companies with weak internal cash generation - low dividend cover and high gearing are pretty good signals - are most vulnerable to being dumped by fund managers.

Good examples are food manufacturers - particularly Dalgety, Albert Fisher and Booker - which have sky-high yields, but are struggling to find growth in their main businesses. Also on the high-yielding, but weak profits growth, hit list are Thorn, Harrisons & Crosfield, Coats Viyella, P&O, De La Rue, English China Clays and Kwik Save.

Longer term, any cut or abolition in dividend tax credits would depress the value of company pension funds, which are rated by actuaries on the basis of their potential dividend streams. Companies which thought they had a handy pension surplus may have to start paying pension contributions - a real cash outflow which would hit profits - and some might have to increase their contributions. Those most affected will be groups with big, rich pensions funds in relation to their profits or liabilities. Examples include ICI, British Steel, Imperial Tobacco and privatised groups such as BG, the old British Gas, and BT, which has already shelled out pounds 1bn to top up its pension fund after last year's cut in the tax credit.

Greycoat centres on City property

UK Active Value, the "vulture fund" headed by Brian Myerson and Julian Treger, could yesterday lay claim to its second scalp in a matter of days. Last week it was Hogg Robinson and now Greycoat, the central London property group, has confirmed much-trailed plans to sell its flagship office development at Embankment Place in London's Charing Cross for pounds 212m and buy back up to a quarter of its shares on a one-for-four basis at 171p a share. Both companies have received the attentions of UKAV, but neither is admitting the fund had any influence on their plans.

Certainly Greycoat was putting forward a good case for originality yesterday as it revealed that pre-tax profits of pounds 1.3m replaced losses of pounds 300,000 in the year to March. The group was saying, with some justification, that it had been apparent since at least 1993 that Embankment Place, representing half its pounds 419m property holdings, made its portfolio top heavy. Yesterday's deal, understood to be with the Brunei Investment Authority and done at the equivalent of a 7.5 per cent net yield, suggests it was worth waiting.

Gearing will now fall to 62 per cent, allowing plenty of headroom to finance the other pounds 50m required for the redevelopment of the group's three big City development properties at Gresham Street, Bishopsgate and Great St Helens. Those should be ready in nice time for the peak of the current cycle, which Greycoat expects in 1999. By the same token, Moor House, the other potential pounds 100m project in the City, will not be proceeded with unless a 50 per cent pre-let can be obtained.

Barclays de Zoete Wedd is forecasting a rise in net assets per share from the current 172p to 195p this year. So the shares, up 2p at 165.5p, look reasonable value as a punt on London property.