THE INVESTMENT COLUMN
When Dalgety paid pounds 440m for the European pet food business of Quaker Petfoods a year ago, the hope was that the deal would help transform the business from a dull dog of a company into a more lively animal.
Few quibbled with the strategy. The idea was to move from being a bit- part player in the cut-throat food sector to a powerful force in one market - pet food, with two other businesses in agribusiness and food ingredients.
The Golden Wonder snacks and Homepride sauces were sold for pounds 280m to help raise funds for the deal, with the remainder coming from a rights issue.
If there were doubts about the logic they centred on the price Dalgety paid. At this level, it needed everything to go right to achieve the kind of returns it was promising. Yesterday's results showed that the plan has gone badly awry.
The 14 per cent rise in pre-tax profits to pounds 69.4m for the six months to December flatters the company as it includes a net pounds 22m from the various disposals and acquisitions.
At the operating level profits were down from pounds 61m to pounds 47m with the worst problems centred in pet food, where trading profits fell by pounds 5m. This was partly due to a fall in sales at the end of the year though the excuses for the decline were fairly colourful. According to Dalgety's chief executive, Richard Clothier, Britain's pet owners have been downsizing their dogs, preferring to buy smaller pooches which eat less. On the cat front, Britain's fussy moggies have shifted their favours towards cans with chunky meat bits while Dalgety was moving towards pate-style offerings. What he did not say was that Dalgety had replaced meat chunks with vegetable substitutes in its Arthur's brand to save costs but seen the move backfire.
The company is pushing ahead with the rationalisation and it will achieve its pounds 40m of cost savings by next year instead of 1998 as originally forecast.
Profits at agribusiness were up by 25 per cent to pounds 21m, though this was largely due to the acquisition of the Pig Improvement Company. Margins have been badly affected by rising raw material costs, particularly in wheat and soya.
In food ingredients, profits were down 17 per cent at pounds 15m with rising raw material costs again a key factor.
Dalgety shareholders have watched the shares drift down from 484p in August to 413p, a further 2p easier yesterday. The outlook does not look encouraging. BZW has cut its forecast from pounds 132m to pounds 122m for the full year, which puts the shares on a forward rating of 15. With a recovery still dependent on everything going Dalgety's way, the upside looks limited. Sell.
Property goes derivative
The latest attempt by a group of investing institutions to create a viable property derivatives market as an alternative to investing directly in property underlines the air of crisis surrounding the industry. Last year's 15 per cent underperformance of the market by property shares followed a 14 per cent lag in 1994 and it is impossible to find a sector analyst who sees an end to the slump.
It is becoming a familiar story, but property companies once again had to struggle with flat rental values and rising yields. The combination of those meant property values slipped 5 per cent during the year.
The industry's problems are legion, but one of the newer and most worrying concerns is the very status of property as an institutional investment. The asset class sank to only 5 per cent of pension fund assets by the end of the year, compared with 14.5 per cent in 1981. At that time insurance companies had been even more heavily skewed towards property, with 21 per cent of their assets in bricks and mortar.
The worries about the speed with which institutions can buy and sell property when pension funds are being encouraged to invest in ever more liquid assets is one of the driving forces behind attempts to develop a securitised version of the sector. Whether it can succeed after many previously stalled attempts remains to be seen.
With a drip-feed of disinvestment from the sector, attention focuses on the prospects for rental growth and the movement in the yields surveyors use to calculate capital values. This is a mixed bag, with falling bond yields around the world making current property yields look generous, but rents are still under the cosh from slow-growing employment and the number of properties offering no growth because they are currently being rented at levels higher than the going rate.
Flat rents cause two problems for property companies. They put the lid on asset values, which is one of the key determinants of share price - depending on the mood of the market, property shares trade at either a premium or discount to this benchmark. But perhaps more importantly they restrict the flow of revenue from which a company can pay dividends. To create a healthier cash flow companies are forced to rely less on contractually guaranteed rents and more on trading profits.
In these difficult circumstances, selectivity is the key. The only property companies to outperform this year will be niche players such as Trocadero and Capital Shopping Centres and good asset sweaters like Asda, Burford and Chelsfield. Forget the majors which, with the possible exception of British Land, really only track the market as a whole.
Ferguson feels the squeeze
Ferguson International is yet another name to add to the victims of the high street downturn. The labels group warned of a disappointing start to the second half when it announced the sale of its coat-hangers business in October. Yesterday it was forced to admit that trading had been even worse than expected.
Normalised profits will dip from last year's pounds 12.8m to pounds 11.5m in the 12 months to February, the company forecast, before a net pounds 1.5m exceptional charge, mostly relating to the hanger division's withdrawal from German production.
Ferguson has been squeezed between the reluctance of consumers to spend on the garments and food for which it provides labels and hangers, and the soaring cost of raw materials. The worst pain has been on the garment side, as margin pressure from retailers like Marks & Spencer feeds down the production chain. There have been similar problems in food, where the big supermarkets are bearing down on suppliers. That has prevented Ferguson passing on cost increases of between 6 and 50 per cent over the past year.
The group has taken out 80 jobs since October and further cost-cutting measures are in the pipeline. In a carbon copy of the strategy of rival Jarvis Porter, it plans to move into more profitable areas like toiletries, while strengthening the existing US computer-labelling business.
If Ferguson realises net asset value of pounds 20m on the disposal of the hangers operation, gearing should tumble to around 20 per cent. The shares, down 21p to 196p, stand on a forward multiple of 10. Jarvis Porter looks more exciting.
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