THE INVESTMENT COLUMN
Thursday 12 October 1995
On the face of it, the revelation that the Chancellor, Kenneth Clarke, and Bank of England Governor Eddie George are in no mood to cut interest rates is bad news for gilts. But few really expected any reduction and on most counts the immediate outlook remains good.
The market for government bonds is more homogeneous than that for equities and marginally less erratic. Its prospects are highly dependent on what the market thinks will happen to inflation and interest rates, although the market also takes account of the relative attractions of UK bonds to UK equities and to US and German bonds.
On inflation, the 1990 commitment to keep a lid on prices has survived devaluation in 1992 and has not been seriously challenged since. There is reason to believe that interest rates have reached their peak in the current economic cycle, while inflation rates could also be close to the top. Yet gilt-edged stocks with 10 years to maturity, currently yielding between 8.25 and 8.5 per cent, are discounting worse to come. The real rate of return of 5 per cent is high and attractive by historic standards.
The state of government finances could cause worries for the market. The public sector borrowing requirement is likely to overshoot the target this year by anything between pounds 5bn and pounds 9bn, but the longer-term outlook is better. The Government is likely to finance tax cuts by cutting spending rather than increased borrowing. Meanwhile, fears of an incoming Labour government behaving irresponsibly have been quelled by the iron resolve of Tony Blair to win the confidence of financial markets.
Institutional demand for gilts should also hold up, in spite of last month's wobble, when the auction was undersubscribed for the first time. Share prices could begin to look vulnerable once the current takeover froth subsides, increasing the attractions of bonds. Further underpinning should come from overseas investors. Nikko, the giant Japanese bank, expects Japanese institutions to buy more gilts following further recent relaxation of controls on outward investment.
Together, the evidence suggests that this is no time to reduce gilt holdings.
Workwear firm recovering poise
Alexandra Workwear has been attempting to recover its poise ever since demand for its uniforms and its share price fell off a cliff, forcing a dividend cut in 1992.
The atmosphere now is very different from the heady 1980s, but against the background of a sluggish and highly competitive market, the company has done well to raise profits 27 per cent to pounds 2.74m in the 28 weeks to 12 August.
Trading margins improved from 6.8 to 8.2 per cent as Alexandra successfully clawed back the rise in raw material costs that led to disappointing results last year.
Price rises accounted for between 4 and 5 points of the 7 per cent increase in turnover to pounds 35.7m. The rest came from efforts to upgrade products like boiler-suits, with resulting margin improvements.
The company says that the increase in raw materials has now levelled off, but it is not banking on last year's 8 per cent hike being reversed. Meanwhile, the market continues to do it few favours, with little sign that the caution of buyers is lifting.
Other factors, however, should continue to underpin its recovery this year. For a start, Alexandra is without the start-up costs incurred in 1994 on four new shops. It should also see a reduction in finance charges as gearing, 15 per cent in August, falls close to zero by the year end.
Further out, next month's expected consolidation of four sites on to one at Bristol should eventually produce cost savings of pounds 500,000 a year.
Alexandra has built up a commanding 35 per cent of its market on the back of its quick-response service, saving the customer the need to carry large stocks. But that may not be enough to protect it in another downturn, even if the balance sheet has been restored to health.
Profits of pounds 5.4m this year would put the shares on a prospective price/earnings multiple of 16. High enough.
the Ashanti trail
Pioneer Goldfields will be following a trail blazed last year by Lonrho's Ashanti when it comes to the stock market next month. Both have Ghana, West Africa, as the focus of their operations, an area to which investors have hitherto had little access.
Like Ashanti, Pioneer will be a substantial group. Depending on the final offer price, expected to be between $9.50 and $10.50 a share, it will be capitalised at between $712m and $788m. According to yesterday's pathfinder prospectus, that would put a value of between $77.40 and $85.60 on each of the group's 9.2m ounces of proven and probable gold reserves. A fifth of the group is being offered for sale by the parent company, Pioneer Group of the US. The notional yield at the offer price is 1 per cent, with first dealings expected on 8 November.
Pioneer offers a relatively low cost, low risk way into West African gold mining. Cash costs at $196 an ounce for the six months to June are well below a world average, nearer $250, and the heap leaching process it employs is relatively straightforward compared with Ashanti's deep mined gold. That is illustrated by the latter's recent warning that it would miss its production forecasts this year after disruptions caused by drought and floods.
Production is set to rise from the current 235,000 ounces to 400,000 by 1998, making it one of the top 20 mines in the world. But investors should beware the political risk and, despite the differences, bear in mind the fate of Ashanti, where the share price is right back where it started last year.
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