THE INVESTMENT COLUMN
Wednesday 07 February 1996
Just when they thought it might be safe to come out, Allied Domecq's shareholders were dealt another sickening blow yesterday. The wine, spirits and retailing group's ability to shock even its sharpest critics really does know no bounds.
Even the way the bad news is delivered is becoming something of an art form. Michael Jackaman, the retiring chairman, began his opening address to yesterday's annual meeting with the now customary platitudes about Allied's strategic focus, before smacking shareholders between the eyes with a warning that first-half profits would tumble 20 per cent. Some of the reactions from analysts yesterday were not surprisingly unprintable.
True, Allied has suffered from genuine bad luck. There was little it could do about the shooting of one of Mexico's presidential election candidates in the early hours of the day on which the deal to buy Domecq was clinched. However, a great deal of the other calamities are of Allied's own making.
Sir Christopher Hogg has his work cut out when he assumes the chair in the spring. Investors can only hope that he brings the best out of Tony Hales, chief executive. He has yet to do his undoubted skills justice since taking management control of the group following Allied's foreign exchange disaster five years ago.
Allied is clearly out of step with its main rivals, Guinness and Grand Metropolitan, in the global spirits business. Yesterday's excuse that profits from spirits in the US were being hit by destocking really does not wash given that Grand Met and Guinness raised the alarm over this problem 18 months ago.
Moreover, it raises an interesting question. If the distribution pipeline is jammed with Allied's products, how much of the profits booked in previous years were flattered by over-ambitious shipments of spirits to the US?
Allied's push to slim down to a more focused group has also, surprisingly, caused its share of financial pain. The raft of food business disposals, such as Tetley Tea and Lyons, has led to a dilution of earnings.
This sorry tale of woe was greeted in the City by across-the-board downgrades of pre-tax profit forecasts for the current year from around pounds 640m to pounds 580m. At that level, earnings per share will be 34p, implying a prospective p/e of almost 15 on the share price, which fell 8p to 507p. That is not demanding, especially backed by a 6 per cent yield - assuming Allied does not take the axe to the dividend, which analysts expect to be around 25p. But the biggest attraction of all remains Allied's increasingly serious credentials as a takeover target.
Investors warm to Farnell deal
With shareholders voting next Thursday on Farnell's proposed acquisition of its big American rival Premier, the electronic component distributor will have been relieved to watch its shares' recovery since the market's knee-jerk reaction on the day the deal was announced. While the vote is hardly in the bag, it would be surprising if investors were buying the stock only to shoot the deal down.
At 454p they have recovered nearly all the ground lost since the City started fretting about the short-term earnings dilution caused by the acquisition, the high levels of debt Farnell will incur to fund it, and the graveyard that the US has been for many other British companies trying to replicate their success over here with ill-conceived deals over there.
Those worries are real enough with the company more than doubling its size and wiping out its net asset backing with a sizeable goodwill write- off. But improving sentiment has focused on the earnings growth offered.
Where will it come from? First of all, by pushing Farnell's 45,000 products through the customer network of Premier's Newark subsidiary - and Newark's 120,000 components through Farnell's. Newark has 100,000 customers compared to Farnell's 60,000.
Next, by improving the operating efficiencies of Newark, which enjoys a 20 per cent net margin compared to Farnell's 27 per cent. Bringing the acquisition's three- to five-day delivery targets in line with Farnell's 24-hour promise will help, as will improving the relatively low 75 per cent chance of having an item in stock - Farnell's equivalent hit rate is in the high 90s.
Other gains will be made by reducing central overheads in the US, generating incremental sales from the already launched Farnell US catalogue and putting together IT, publishing and other functions.
NatWest Securities believes Farnell could turn earnings per share for the year just finished of 35p into 65p by the end of the decade. Two years out, the shares stand on a prospective p/e ratio of 14. The shares are still good value and the deal should be waved through.
Clyde explores Indonesian oil
The 1990s have proved a rocky ride so far for Clyde Petroleum, the misnamed Herefordshire-based oil company. In the space of just two years up to the middle of 1992, the shares lost close to nine-tenths of their value, but in the last 13 months they have outperformed the market by 28 per cent.
The catalyst for change was the appointment in July 1994 of Roy Franklin, a former BP executive, as managing director. He has been instrumental in shifting the focus of the company away from exploration towards lower- risk acquisitions which can profitably recycle some of the group's cash flow from oil production in the North Sea and Dutch gas fields.
The result has been a string of deals over the last two years or so, but yesterday's completion of the purchase of a 31 per cent stake in Marathon's Indonesian producing assets for $51m marks a steep change in the strategy.
The acquisition, Clyde's first move into Indonesia, fulfils Mr Franklin's ambition to add another leg to the business and makes it an operator of oil assets for the first time for some years. The tax take, at 85 per cent of profits after exploration, development and operating costs, is high in Indonesia.
But the attraction lies in the development of assets which currently amount to an effective interest in 11 million barrels of oil. Clyde reckons exploration can raise current production of around 7,500 bpd by around 50 per cent using existing production and handling facilities. Like the North Sea in the 1980s, the tax regime means that the government will pay for most of the development costs as tax write-offs.
Previous deals in the Netherlands have paid off handsomely, but the shares, down 0.5p at 58.5p, are still hovering just below net asset value. The strategy looks sound and Clyde's strong cash flow could attract a bidder, but the shares are likely to mark time while the Indonesian deal proves itself. Hold.
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