Uncertain market for Smurfit

The Investment Column

The outlook for the paper cycle has seldom been so uncertain and Jefferson Smurfit, the Irish paper giant, is not alone in being unable to guess "whether the recent industry inventory correction represents a de-stocking pause or the end of the cycle".

After soaring last year, prices in some areas of the industry have come rattling back down again. Pulp, for instance, is now selling for around $500 a ton compared with $925 in October. At the same time there is no shortage of capacity, particularly in the US where new plant is set to further increase supplies of the corrugated board used in packing cases.

All this gloom is hard to reconcile with Smurfit's bounding optimism six months ago and yesterday's announcement of record 1995 profits totalling Irpounds 420m (pounds 433m), the highest ever seen by an Irish company. But Dermot Smurfit, joint deputy chairman, refuses to be downbeat.

Certainly, the group has world-leading positions in areas ranging from boxes and cartons to the container board that goes into them. It also supplies much of the paper used to make its own products, helping to reduce exposure to the more volatile parts of the paper markets. Smurfit points out, for example, that the fall in price of corrugated boxes - from around $873 a ton in the autumn to $820 now - is nothing like the drop in other areas. Smurfit's wide geographical spread also helps to spread risk.

Those strengths meant the group was able to cash in on last year's price recovery, although the results were distorted by acquisitions and a change of year end in 1994. The first full 12 months of Cellulose du Pin, the paper and packaging operations of Saint-Gobain acquired for Irpounds 684m in 1994, boosted profits from continental operations from Irpounds 34.6m to Irpounds 195m last year.

Even so, with a return on capital well in excess of 20 per cent last year, the group has a fair chance of achieving its target of 15 per cent across the business cycle. The problem is that, given the integration of the world-wide industry, Smurfit's strengths become weaknesses in a downturn. Along with rivals, Jefferson Smurfit Corporation, the group's 46 per cent-owned separately-quoted associate in the US, had to shut mills at the end of last year.

Profits cut to Irpounds 260m this year would put the shares, up 3p to 163p, on a lowly forward multiple of 10. Apart from uncertainty over the cycle, Smurfit's rating suffers from the group's state of limbo between the Irish market, which it has clearly outgrown, the UK and the US. The expected appointment of a new chief operating officer in the next few months will help clear up corporate governance worries in the UK, but it has still not been fully welcomed into the British investment community. A recovery may be some way off yet.

A smart turn-out from Moss Bros

In a low inflation, highly competitive menswear market, producing an underlying 9 per cent rise in sales was an impressive performance from Moss Bros. Coupled with a healthy opening programme, and on a relatively fixed cost base, profits really took off, jumping 53 per cent in the year to January.

The pounds 11.3m pre-tax profits for the 12-month period represented a 31.3 per cent return on shareholders funds, a chunky improvement on last year's 22 per cent return and a massive increase on the 5 per cent return on assets recorded in the bleak days of the early-1990s recession.

Investors shared in the good news with a 50 per cent rise in the full- year dividend to 18p (12p), almost four times the payout five years ago. Despite heavy, and rising, capital expenditure, strong positive cashflow has kept the south London-based group's cash balances at almost half shareholders' funds.

That financial security underpinned the addition of 22 shops last year to take the total to 129 by the year end. A further 10 or 12 are planned every year for the rest of the decade and the company is confident the intrinsic operational gearing of the business will ensure that margins continue rising during that period.

How Moss Bros has bucked the trend on the high street is something of a mystery, explained only in the vaguest terms by the company - providing better service, creating a welcoming atmosphere - but no one will argue with the figures. The Moss Bros formula, now spread over Savoy Taylor's Guild, Suit Company and Cecil Gee, is working.

Investors who have seen the shares rise almost eightfold during the past three years certainly have no gripes. Since the beginning of 1993, the shares have outperformed the market by more than 300 per cent, rising from 139p to yesterday's 795p, up another 36p on the day.

What Moss Bros seem to have got right is to realise that shopping for most men is a bit of a penance. Making the process as easy as possible ensures return trade and encourages higher spending on each trip - to get it all out of the way. With prices rising by a negligible 3 per cent last year, volume is the key, so an increase in market share from 7 to 9 per cent and a further jump in sales per employee are encouraging signs.

On forecast profits of pounds 14.2m this year, the shares trade on a prospective p/e of 15. That represents an 8 per cent premium to the rest of the market, but in the context of 26 per cent earnings growth it is justified. Still good value.

Yule builds on its reputation

Yule Catto has managed to reduce earnings per share only once in the past 15 years. Most investors will be happy to forgive the chemicals group that one blemish on its record, particularly since it related to losses on a Dutch building products subsidiary in 1993 when the construction industry was hardly booming.

Yesterday's figures for 1995 served only to reinforce the group's solid reputation for growth. Pre-tax profits up 16 per cent to pounds 33.1m for the 12 months to December were only a tad less than expectations six months ago, despite a ferocious year for raw material prices. Styrene, one of the group's key inputs, doubled between the second and third quarters and has since come back down to where it was at the beginning of the year.

It was therefore hardly surprising that Yule suffered a margin squeeze of more than 1 per cent in the second half. It did well to hold the drop in operating margins over the year to just 0.2 per cent, leaving them at a still healthy 8.8 per cent.

The continuing recovery in building products, which encompass businesses like roof lights, office partitions and sheet plastic helped the figures. The division did well to raise profits from pounds 6.3m to pounds 7.61m in the face of a dismal UK construction market, reflecting continuing benefits from shaking up the business three or four years ago.

The outlook should now be set fair for a period of more stability for the group. Order books on the building side are back to "sensible" levels, chemical volumes look like holding up and, more importantly, steadier raw material prices should allow margins to bounce. Profits of pounds 38m this year would put the shares, unchanged at 336p, on a market rating of 14.5.

Still reasonable value, although the 20 per cent family holding and 29 per cent held by Kuala Lumpur Kepong, a Malaysian plantation group, make for a tight market.

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