The Investment Column: Pace will struggle to keep step with digital revolution

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The Independent Online
PACE MICRO, the maker of set-top boxes for digital television, came to the market three years ago and soared from around 160p to 241.5p amid expectations that the world would sign up for cable television.

But the public had less enthusiasm for cable television than the market had for Pace's shares, and they hit a low of 25.5p last year. The company has since abandoned analogue technology and put its bet on the success of digital set-top boxes. The hype over digital has worked wonders for the shares, which closed yesterday bang on 200p. Is the market making the same mistake again? Well, yes and no.

The bull case for Pace now, as in 1996, is made on the basis of growing demand for its digital boxes. Fans of the stock justify its high rating with reference to the popularity of the set-top box give-aways by BSkyB and OnDigital. They cite expected growth in global demand for the boxes from 20m units next year to 60m in 2005. Meanwhile, Pace is poised to break into the US market. That has 65m homes, only around 3m of which are digital subscribers. Since the US represents around a third of the global market, Pace could dramatically raise its 8 per cent proportion of global sales. This is all germane. The reality, however, is that Pace is learning the age-old lesson that while being small encourages innovation, it is the established players who reap the rewards.

Pace has four big competitors, including electronics giant Phillips. The Dutch company is being particularly aggressive, pursuing volume at the expense of margin both in Europe and in South America. The Brazilian market has already crumbled following the collapse of the real against the dollar. Pace lost sales in every operating region except the UK last year.

Pace's move into the US will put it head to head with GI and Scientific Atlanta. John Dyson, Pace's finance director, claims Pace has a better and cheaper product than both. The problem is that these incumbents have cosy relationships with the US cable companies which Pace will find it hard to destroy. In any case, if it can't win the price war with Phillips, what hope with GI?

Williams de Broe expect pre-tax profits of pounds 18.9m and earnings of 6p per share this year, putting Pace on a heady forward p/e of 33. Of course, Pace may become an attractive takeover target, but capitalised at pounds 449m that looks unlikely. Investors should take profits before the competition really bites.

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Druck Holdings

LEICESTER-BASED engineering company Druck Holdings is a company for the boys. It makes pressure sensors for oil rigs and Formula One racing cars, altimeter calibration equipment for USAF F16s. Its latest contract is for the Eurofighter, the Typhoon. One needs courage to invest in the stock.

John Salmon, the chief executive who with co-founder Mike Bertioli owns 51 per cent of the shares, says the company does not enjoy any niches, despite the sophistication of its technology.

It wins contracts on the basis of its existing reputation and the quality of its engineering technology. The market is highly fragmented, with each of its four divisions all facing different competitors in different parts of the pressure sensor industry.

Although Druck's results look impressive - sales up 16 per cent, pre- tax profits up 18 per cent - the immediate underlying outlook is less firm. Exceptional orders from the US Army and Navy bolstered the numbers. The order from the US Army has been terminated earlier than expected and Druck is to supply 500 units instead of 1000. Meanwhile, 85 per cent of sales are destined for outside the UK while 75 per cent of Druck's manufacturing is based here. The strong pound is taking its toll. The slump in the oil and petrochemicals industry has hit demand for Druck's products.

On the upside, Druck is enjoying healthy demand in Germany, Italy and France. Although the Typhoon contract is worth only pounds 1m, it could lead to further orders worth pounds 10m or so. In the meantime, Druck is launching a range of new products this year and has the Australian airforce and civilian airlines in its sights. Druck's small size and the illiquidity of its stock make it a volatile share. Analysts expect pre-tax profits of pounds 14.5m and earnings of 14.2p per share this year, giving it a forward p/e of 18. Although Druck's long-term prospects are firm, the shares are not cheap.

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RJB Mining

RJB MINING, the UK's largest coal producer which was formed from the privatisation of British Coal, yesterday clinched the largest of the coal supply deals it is currently negotiating. The shares tipped up 2p at 51.5p, just above a recent all-time low of 47.5p. Should bargain hunters pile in? The contract, with Alcan Smelting and Power UK, is hardly of the scale of existing deals with other UK power generators. The further contracts remaining to be sealed are even smaller, together amounting to about the same value.

Meanwhile, RJB continues to suffer from the strength of sterling and depressed world coal prices. It is struggling to compete with cheap imports from South Africa, South America, Indonesia and Australia. In May RJB warned volumes would be down because of protracted negotiations with its workforce earlier in the year.

But yesterday's contract win indicates the competition is not strides ahead. Should the coal price strengthen and the sterling-dollar rate weaken, RJB will be looking attractive to larger quoted miners such as Lonmin and Anglogold.

RJB is already trading below its net asset value; its agricultural property assets are worth its share price alone. Paribas expects pre-tax profits of pounds 15m and earnings of 7p per share this year.

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