The Investment Column: Wolseley steers a risky course, but the shares look good value

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The Independent Online
THE FATE of Wolseley's shares demonstrates how vulnerable building materials companies are to fears that higher interest rates will arrest housing market growth.

The shares have plummeted from their 564p high to 421.75p. Put them on the same rating as their sector peers, and this implies that Wolseley will deliver earnings one-third below forecasts. Is the market's extreme scepticism about Wolseley justified?

With 54 per cent of profits coming from the US, the company's warning of a slowdown from the high levels of growth enjoyed since 1997 indeed causes concern. To justify Wolseley's present rating, however, such a slowdown would have to see US profits halving.

The company is expanding aggressively by acquisition in America, adding 50 new sites this year. A slowdown would in fact present further opportunities to grow by acquisition.

There is also concern about continuing pricing pressure. As a distributor, this softens Wolseley's margins. Even so, underlying margins are heading upwards as bolt-on acquisitions and new sites deliver scale economies.

The group - already the world's largest distributor of plumbing and heating equipment - spent more than pounds 310m on acquisitions this year, mainly in Europe. Investor concern should focus on the difficulties here. Wolseley's foray into Austria, where the market has reversed, looks misjudged.

Organic profits growth in its European operations was 3.6 per cent, against 12 per cent in the US. Yet it is in Europe that chief executive John Young plans to replicate the successful UK business. The risk is that a rival with better knowledge of Mr Young's target markets might build up similar economies of scale.

Analysts expect pre-tax profits of pounds 355m and earnings of 41.5p per share this year, putting the shares on a price/earnings ratio of 10. Despite the risks, that's cheap given Wolseley's historic double-digit growth. The shares are good value.