Tough balancing act at Severn

THE INVESTMENT COLUMN
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Like its peers in the water supply industry, Severn Trent is finding it hard to maintain an acceptable balance between its customers and shareholders. The group has done a reasonable job for the latter since privatisation in 1989, producing rising earnings and dividends. But increasing resentment at the soaring prices suffered by its customers to finance a massive capital investment programme worth pounds 2bn over five years has boiled over this year.

The political furore that led to the widespread announcement in the industry of "benefit-sharing" packages, involving rebates to customers and special dividends, has been made all the more embarrassing by the drought.

The resulting hosepipe ban and its continuance into what is normally thought of as winter has forced Severn to announce a pounds 130m top-up to its spending schedule. The problem for Severn is that keeping a clamp on costs to keep shareholders happy has left it unable to cope with the exceptional conditions of the past summer.

The measures unveiled yesterday will see pounds 40m invested in increasing supplies, an increase of pounds 10m to pounds 25m a year for five years on stopping leaks and a further pounds 40m put into improving local distribution networks. The hope is that the latest increases should prevent a repeat of this year's red faces and prove only a blip in the progressive reduction of debt. As importantly, the moves could help to head off political and regulatory attempts to limit profits.

The drought aside, the group has continued to produce the goods in its main water and sewerage business. The underlying increase of one-eighth in operating profits, ignoring last year's pounds 55m exceptional charge, takes the half-year total of pounds 206m to the same level as for the whole of 1991. Ahead of pounds 6.7m spent on drought-related work, direct operating costs rose only 1.4 per cent as the effects of last year's restructuring started to feed through.

The picture elsewhere is less inspiring. The pounds 212m paid in 1991 for Biffa, the waste company that remains Severn's main diversification, still looks too high. Operating profits rose 34 per cent to pounds 10.2m, but the waste arm remains several million pounds shy of breaking even after financing charges. Other businesses saw their contribution fall from pounds 2.1m to pounds 700,000, suggesting that Severn still has a long way to go in diversifying away from its heavily regulated core operations.

Full-year profits of pounds 370m would put the shares at 679p, up 11p, on a lowly forward rating of below 8. With a prospective yield of 5.9 per cent they might be thought to be fully discounting the political uncertainty, but the risks until the election remain sizeable.

Morland stays ahead of rivals

Morland has been a remarkable success since the beer orders turned the industry upside-down six years ago and full-year profits up a useful 11 per cent in the 12 months to September continued the good news. Over the past five years the company has consistently outperformed the other regional brewers in earnings and dividend growth.

After a 10 per cent increase in sales to pounds 62.6m, pre-tax profits before exceptional property disposals were pounds 11.02m (pounds 9.96m). Earnings per share, up 9 per cent to 35.7p, allowed a 12 per cent jump in the full-year dividend payout to 11.8p, 2.6 times covered.

How has Morland achieved this in an industry otherwise troubled by flagging sales, rising costs and squeezed margins? First it is small enough to be able to grow despite a stagnant market as a whole. It is well managed, has a sensible strategy for growth and a good track record of implementing it.

Although Morland is best known for Old Speckled Hen, its highly successful beer brand, brewing actually contributes less than one-fifth of profits and with margins being squeezed and a bigger proportion of sales going through lower-margin free-trade and off-sales outlets that percentage will decline further. That said, reducing the brewery's dependence on its tied estate and focusing on a handful of high-margin brands was the right strategic move.

The rest of Morland's profits come from tenancies and managed pubs, with the latter growing fast as the company adapts new concepts from its larger rivals such as Whitbread - profits in managed pubs rose 30 per cent in the period. Tenancies do not have the same growth potential but they provide a good steady wholesale business for the brewing arm and generate significant amounts of cash. Volumes during the year held up much better than the market as a whole, which slipped 5 per cent.

Overall, Morland is in good shape, with negligible gearing, and steady growth pencilled in. Profits before tax next year of more than pounds 14m put the shares, up 3p to 520p, on a prospective price/earnings ratio of about 13. After the underperformance of the past three years, they are good value.

Norcros creeps back into black

Norcros, the troubled former mini-conglomerate, has hacked off so many limbs in the past few years that what remains is barely recognisable. The latest disposals, five building materials businesses, have raised a further pounds 51.4m.

The print and packaging division, specialising in labels for supermarkets and the Underground tickets that include the "clever" magnetic stripe, is the next on the list. This will leave Norcos with just its ceramics division, including the Triton shower business, and the focus will be complete.

As an investment, however, Norcros has been an unmitigated disaster. After trading at over 400p in 1988 the shares have plummeted to just 75p yesterday, down 3p on the day, but the outlook is starting to look encouraging. Yesterday's results showed a return to the black with pre-tax profits of pounds 18.7m in the six months to September compared with last year's pounds 9m profit and the full year's pounds 51m loss. Gearing is down to 37 per cent compared with nearly 80 per cent in March and the plan is to sweat the group's assets, boosted by pounds 5m of cost-cutting announced in June.

After considering a merger or flotation of its print and packaging business a sale now looks most likely. Analysts suggest a price tag of pounds 100m. The company said yesterday that it was in talks with several interested parties.

The timing is hardly perfect as margin pressures have forced many print and packaging groups to issue profits warnings. But Norcros management, led by Michael Doherty, is confident that a decent price can be achieved and that a fair balance of the proceeds can be distributed to shareholders.

Analysts are forecasting pre-exceptional profits of pounds 15m for the full year, which puts the stock on a forward rating of 12. That's reasonable given the recovery potential and the possibility of a takeover if management fails to deliver growth.

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