Tarmac finds recovery elusive

The Investment Column
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The Independent Online
As Britain's biggest civil engineering and contracting group, Tarmac ought to have good idea of the lie of the land. The trouble is the company has developed a reputation for erring on the side of optimism too often. Its most costly error was to badly misread the housing market - a decision that ultimately resulted in last year's pounds 600m asset swap with Wimpey's minerals and construction business.

Yesterday Neville Simms, Tarmac's chief executive, again brushed aside the gloom and doom emanating from rival contractors. In particular, he highlighted the cost benefits arising from integrating the Wimpey activities.

These are expected to yield more than pounds 35m - twice as much as previously expected - and will put Tarmac in a strong position when market conditions improve. However, evidence that such a recovery is in sight is as elusive as ever.

In the year to June, underlying pre-tax profits fell to pounds 6.7m from pounds 29.1m, at the bottom of market forecasts, due to tough markets and bad weather. With a pounds 65m exceptional charge for restructuring the Wimpey activities, including 1,400 redundancies of a 26,000 workforce, the half-time loss widened to pounds 58.3m from pounds 15.9m.

The biggest hit was taken in construction services. Profits here shrank from pounds 5.5m to pounds 700,000 as the design consultancy business slipped into a pounds 2.8m loss, versus a pounds 2.6m profit, after orders dried up. Mr Simms admitted that Tarmac, preoccupied with Wimpey, had taken its eye off the ball.

The heavy building materials division fared better, with profits rising a fraction to pounds 39.7m. But the picture here is far from rosy given the heavy exposure to the UK roads programme, which is being cut to ribbons. Volume declines of up to 24 per cent cast doubt on Tarmac's ability to push through single-digit price increases for much longer.

Similarly, doubts must be expressed about Mr Simm's enthusiasm for the Government's Private Finance Initiative, where Tarmac is in contract or preferred bidder for pounds 800m of work. Few other contractors, or financiers, share Tarmac's belief in PFI's prospects.

Of equal concern is gearing of 66 per cent, which must raise a question mark over the 5p dividend being maintained.

Societe Generale Strauss Turnbull has cut its forecast for pre-exceptional profits this year to pounds 68m from pounds 86m and has lowered its 1997 estimate to pounds 94m from pounds 114m. That implies a p/e of 19 falling to 14 with the shares up 3p to 96.5p. Given Tarmac's bias towards the dull UK construction market, that looks expensive.

Steep price for More O'Ferrall

More O'Ferrall, the billboards to illuminated bus shelters group, is the dream investment - it enjoys a dominant position in a fast growing sector and has plenty of scope to grow in immature overseas markets. It is well financed with enviable cash flow.

Interim figures yesterday came with some bad news - the O'Ferrall is to be dropped to better reflect the fact that Adshel, the fast growing bus shelter arm, is now as big in group terms as the core More O'Ferrall billboards operation. There was nothing else to complain about.

Pre-tax profits of pounds 6.2m were 33 per cent higher than last year's first- half pounds 4.7m, struck from a 21 per cent increase in turnover from pounds 39.3m to pounds 47.8m. Earnings per share grew in line with profits to 12.4p and the interim payout rose 6 per cent to 3.6p (3.4p). Strong cash flow helped debts fall 31 per cent to pounds 10.2m.

Driving those good figures was a marked shift in advertising fashion, away from television, which no longer delivers the mass audiences of old, towards outdoor media. Blue-chip advertisers such as BMW, Kellogg's, Pepsi and Procter & Gamble have started using outdoor advertising for the first time this year, but even so 200 of the top 300 brands have never used it. There is plenty of scope for growth through new clients.

Elsewhere, More's new five-year plan envisages growth coming from diversifying away from bus shelters to backgrounds such as recycling bins and public toilets; from increasing yield per site by using shorter campaigns and better illumination; and from expanding in new markets such as South-east Asia.

The problem with such attractive investments, of course, is that they come at a price. On the basis of forecast profits of about pounds 18m this year, the shares trade on a p/e of about 20 at 691.5p, down 2p. For a growth rate going forward in the mid- to high-teens that is pretty steep.

McKechnie is back on track

McKechnie, the plastic mouldings to fasteners group, has been a nice little earner over the years. Hit hard by recession, profits have recovered smoothly during most of the 1990s and, after a pause for breath last year, the group now looks on course to resume the growth track.

Yesterday's figures reflect de-stocking, especially by electronics and telecoms customers, plus the weak market for housing-related products like curtain rails, which hit McKechnie from the end of 1995. Pre-tax profits up 11 per cent to pounds 50.3m in the 12 months to July were only kept moving by the pounds 5.7m operating contribution from three acquisitions picked up during the year.

Even so, the strength of McKechnie's market positions meant it could squeeze another 1.5 points out of gross margins in the year.

The de-stocking problem now seems to have eased, while the recovery in UK housing sales should spell good news - around 15 per cent of the business is dependent on the domestic DIY market. The 10 per cent of sales, mostly fasteners, which currently go into aircraft should also prosper during the current boom in orders. There should be some growth in the automotive side, around a quarter of the group, which will be boosted by a first- time contribution from last month's pounds 15.3m acquisition of Dzus, a maker of clips.

The only question mark is the fifth of sales made into the depressed Australasian new housing market, although McKechnie is confident that will pick up next year. Meanwhile, gearing of 22 per cent leaves the management well placed for further acquisitions.

Profits of pounds 62m this year would put the shares, up 22.5p at 551p, on a forward multiple of 13. Stay aboard.