The Investment Column: Berkeley's 10% profits rise is built on firm foundations

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The Independent Online
WHEN BERKELEY Group finished refurbishing Imperial Apartments in Southampton, whose staircase was copied for the ill-fated Titanic, demand for the flats was so great its directors "were nearly killed in the sell-off".

Yesterday, the property developer was the victim of a less severe sell- off. The City took profits following the shares' steady rise to 775p from 394p since February. Should investors be afraid the shares are about to sink again?

On one view, the Berkeley Group is a simple residential property play, a passive victim of changing demand in its key market, the South-east. Hence the near 50 per cent fall in its shares in the second half of last year amid a residential slowdown, and their recovery in response to cuts in interest rates this year.

As such, Berkeley's long-term prospects are questionable. The impressive growth in the South-east - prices in London are 10 per cent up on last year - are unlikely to be sustained. Indeed, Berkeley, which admits it is not a national player, says that if house prices continue to appreciate at the current rate there will be a correction.

But there is more to Berkeley. It is a trading company with a genuine competitive advantage based on its management expertise in the development of brownfield sites, which account for 90 per cent of sales.

Not only are such abilities distinct to Berkeley - it went into brownfield sites several years before its rivals - they are also matched to today's property market.

Government regulations oblige developers to build on brownfield sites. Berkeley's skill is in identifying the value of a brownfield site according to the possible value of the use it could be put to. It also has a strong brand as a property manager.

The proof of Berkeley's story came in yesterday's results, which saw it raise profits 10 per cent to pounds 110m, despite a decrease in units sold, on the back of a better business mix which lifted average selling prices from pounds 193,000 to pounds 232,000. Many of the types of flat conversion it sold did not exist in the previous year.

Current volumes are 15 per cent up on last year, with average prices up around 3 per cent, as buying-to-let increases in popularity.

Analysts expect pre-tax profits of pounds 30m and earnings of 72p per share, giving the group an expected net asset value of around 577p this year. The shares should continue this year's steady rise and are good value.

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David S Smith

PACKAGING COMPANY David S Smith is unwrapping itself. It has broken up its packaging division to separate boring old corrugated and paper packaging from exciting plastics and logistics.

The group has had a tough time of late, shedding 1,200 of its 11,000 staff this year. The shares tipped up 5.5p at 150p yesterday as the group said it expected stronger markets and announced a further 200 job cuts. But should investors pile in for a recovery?

In the undifferentiated corrugated packaging market, players need to compete on price. David S Smith was once the lowest cost producer in the industry until the pound rose above 2.85DM.

Now it is struggling to compete with continental producers in a market dogged by overcapacity and a decline in demand. The packaging division saw overall operating profits tumble 15 per cent to pounds 32m last year on slightly reduced turnover of pounds 697m as the competition took its toll on margins.

The plastics and logistics side, although it delivered just 9 per cent of group sales, presents better prospects. It generated 17 per cent of earnings as customers responded to consumer pressure to shift to reusable packaging. The group is transferring distribution and management expertise out of corrugated to capitalise on the trends.

Meanwhile, the company's office products division widened losses following costs of starting up operations in Germany. But it should move into profit this year.

Seventy per cent of David S Smith's assets are in corrugated paper and in the short-term only rapid consolidation in the industry will see a dramatic pickup here. With the shares at this level, well below their five-year high of 344p, the group is vulnerable to a bid. Alternatively, it could lead consolidation itself. Chief executive Peter Williams says he has pounds 200m of firepower for acquisitions.

In the meantime David S Smith has some steadily growing businesses which are on the verge on benefiting from recent investment and cost-cutting.

Analysts forecast pre-tax profits of pounds 38-48m this year, indicating the uncertainties surrounding the group. The shares are worth holding.

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Microgen

IN THE near future, every business will be an Internet business. That doesn't mean that all business will be done on the Internet or that the Internet will be the only business. Rather, it means the Internet is a tool for organising and more efficiently executing a wide range of business functions.

A key, if mundane, factor in every business is, of course, billing. If bills are discomfiting to receive, they are a whole lot more boring to process. That brings us to Microgen, a Windsor-based information management services company, which yesterday launched an electronic billing service for business-to-business invoices and related document distribution.

There's little doubt that e-billing removes costs, improves quality of service to e-bill recipients and may even improve cash flow.

Martyn Ratcliffe, the former boss of Dell Computer Europe, who is executive chairman and holds an 8.5 per cent in Microgen, argues that the company is ideally positioned for a widespread switch transition to e-billing. It already distributes more than 25m documents per year for customers ranging from utilities to local authorities. That's probably true, but analysts don't expect any impact to be felt until the 2000 financial year.

Mr Ratcliffe is also pursuing business-to-consumer e-billing. He is vague, however, on what distribution platform will be used, although he insists it will offer a new method in addition to the fast growing net-PC channel. Possible distribution channels could include BSkyB's satellite network or the network of a mobile phone operator.

With Microgen shares up 15p to 180.5p yesterday and the p/e approaching 50-times 1999 forecast earnings, much of the potential appears to be already in the price. Still, Mr Ratcliffe has a strategy and its unfolding will bear watching.

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