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THE INVESTMENT COLUMN: Bowater's promising package

Bowater has come a long way since 1987 when new management set about transforming a ragbag of unrelated businesses into what is now a well-focused printing and packaging company, operating in growing markets around the world.

During the past seven years it has spent more than £1.5bn on acquisitions, raised about £650m from disposals and given shareholders a total return of more than 20 per cent a year.

Despite that impressive record, the shares have been dull for more than 18 months now as investors worried about the ability of Bowater to cope with the raw material price rises that usually characterise the early stages of economic recovery.

They were right to expect the increases but seem to have misjudged the extent to which management could persuade customers to accept the rises in prices. Despite increases of between 70 and 100 per cent for much of the paper and plastic that goes into Bowater's Dior lipstick cases, Allisons bread wrappers and Vaseline pots, and despite the inevitable time-lag between receiving notice of higher costs and passing them on, profits and margins were nicely ahead last year.

Bowater spends about £1bn a year on raw materials, so failing to pass on the rise could easily have wiped out profits.

Pre-tax profits before exceptionals increased 14 per cent to £231m from a 12 per cent rise in sales from continuing operations. After an 11 per cent jump in earnings to 31.2p, the total dividend was a tenth higher at 13.8p.

The extent of the changes imposed over the past seven years is best measured by Bowater's return on sales, which broke through the 10 per cent barrier last year for the first time. One reason for that has been the company's consistently high commitment to capital expenditure, which, as the chart shows, is outstripping depreciation by an ever-widening amount.

The focus now turns to making the existing assets work harder. The investment needed to wring out those extra efficiencies should be available from strong cash flow. At the year-end borrowings had risen to almost 60 per cent of shareholder funds, but the planned sale of the remaining Australian engineering assets could raise £70m, which would take gearing comfortably lower.

Remaining worries include the weakness of the dollar, with 35 per cent of profits generated in North America. Against that, the main economies are strengthening and Bowater should comfortably make £255m this year and £280m next time.

That puts the shares, which at 432p, up 6p yesterday, have fallen 16 per cent since peaking in August 1993, on a market rating. Scant credit for the achievements so far or for the solid prospects.