THE INVESTMENT COLUMN

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Foundations in place for building recovery

The two building sectors, construction (which includes housebuilders) and building materials, have been among the market's worst performers over the past five years.

As the chart shows, the underperformance has accelerated during 1995 as the trading background for their constituent companies has deteriorated. In that context it might seem a reckless call to suggest that the time has come to turn positive on building shares.

But it is a stock market truism that the time to buy shares is when the news is bleakest. This is doubly true for sectors as cyclically volatile as these - according to one estimate, 80 per cent of a sector's outperformance occurs in the first quarter of a change in sentiment, so it is plainly dangerous to wait for the turn before buying.

NatWest Securities, which has just produced a weighty research tome on the building sector, believes the time to go overweight is when the trend in a sector's fundamentals is getting less bad but before that trend has turned upwards again - and well before analysts have started upgrading forecasts once more.

So after a dreadful 1995, what signs are there that things will start looking up in 1996, and which companies are likely to be the biggest beneficiaries?

First, according to NatWest, the current slump is due to a mid-cycle pause in the wider economy that will necessarily be short-lived.

In other words, this downturn is more like that experienced in 1985 before a resumption of strong growth, than the sharp downturn of 1989-92.

The underlying economy is in reasonable shape, which should lead to a small increase in building demand (see the chart) of perhaps 1 per cent compared with an estimated 2 per cent decline in 1995. Housing starts should rise by up to 4 per cent after a year of substantial de-stocking in 1995.

As a result of these trends, earnings growth will be faster in 1996 than 1995, a reversal of what analysts had previously expected, and that will make share price ratings appear increasingly attractive.

That would not be difficult - the contracting sector is only 3 per cent off its all-time low and building materials companies, which have fared slightly better, are less than a tenth off the low point achieved in 1992.

Other bullish factors include a probable peaking in interest rates for the foreseeable future thanks to a slowing in the wider economy and the expectation of more active consumers next year. In short, growth should return in the second half of next year.

So who will benefit most? In the long term, a reversal of a decade of underbuilding as industrialists begin to expand capacity and householders resume shelved repair and maintenance spending will help across the board.

In the short term, however, 1996 will be characterised by a re-stocking of housing starts that will favour the producers and distributors of building materials. BPB, CRH, Redland and RMC look interesting among the materials groups, with Meyer, Wolseley and Travis Perkins favoured among the distributors.

Oil giants on

a slippery slope

After a relatively upbeat 1995, the prospects for the UK oil sector are on the skids again. New research from Nikko Europe, the broker, suggests the operating environment is getting tougher, putting pressure on earnings and dividends forecasts .

This deterioration will upset some of the industry's more optimistic estimates and cause the oil majors to underperform.

Pressure on the oil price, which is being squeezed by a number of factors, and pressure on downstream margins will leave integrated oil companies such as BP struggling.

Nikko expects explorers such as Lasmo and Enterprise, with their now improved focus, to provide the sector's relatively safe havens.

The firm is predicting a further fall in the price of Brent crude, which has already been weak ahead of the Opec meeting on 21 November. As production from the non-Opec countries has been increasing, even a roll-over of Opec's quotas will lead to over-supply and pressure on prices. That will offset any rise stemming from a possibile oil embargo on Nigeria as a result of the current diplomatic fracas. The net result is expected to be a $1 decline in the price to $16 next year.

Such a scenario would normally hit the exploration groups, but Nikko expects them to buck the trend thanks to increasing exploration expenditure and the adoption of a more focused strategy . Lasmo, for example, has sold off peripheral interests. Hardy Oil & Gas has sold its Canadian operations and is considering pulling out of other areas such as Algeria and Namibia.

The benefits were evident yesterday when Hardy reported pre-tax profits of pounds 254,000 for the six months to September compared with a loss of pounds 634,000 last year.

Refining margins are forecast to improve after the grim levels seen this year where returns were affected by over-capacity. Whether that will make up for a less promising outlook on the forecourt, where increasing competition from the supermarket groups is eating into the oil companies' market share, is a difficult call. In the UK the supermarket groups such as Sainsbury and Tesco account for 20 per cent of the petrol retailing market. In France the hypermarkets have grabbed more than 40 per cent.

To combat this, the oil majors are having to improve their non-oil offer in petrol stations by adding convenience stores and selling a broader range of goods. BP has already enjoyed some success by doing this as well as weeding out poorer performing low-volume locations from its portfolio.

Of the oil majors Shell looks the most defensive with its strong balance sheet and yield premium. BP remains more highly geared and is on some sell lists along with Burmah Castrol and Total. Of the explorers, Enterprise and Lasmo look the most promising.

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