Big is not necessarily beautiful at Billiton

Fitness First; Coffee Republic

The world's biggest mining group is created today. Billiton is ready to complete its £22bn merger with BHP of Australia, forming a commodities giant with interests ranging from aluminium, through steel and coal, to oil and gas. But this sprawl makes it a less attractive investment for the time being than old Billiton would have been.

Billiton has traditionally been a focused play on global economic recovery, because of its high exposure to industrial metals. That is being deliberately diluted today in the hope of greater stability of earnings and more industry firepower. It looks a little like "Rio Tinto plus oil", and it is less likely now to outperform its sectormate.

It is poor timing, too, that Billiton's exposure to aluminium has been diluted from 45 per cent of group turnover to 12 per cent in BHP Billiton. More than 10 per cent of the Western world's aluminium smelting capacity is shut because of high energy costs, particularly in the US, which has kept aluminium prices from falling too far. The merger at least strengthens Billiton's balance sheet, which had begun to look stretched, and ensures that it can spend quickly to bolster its capacity when demand returns.

Its biggest strategic worry is over the oil and gas interests in BHP. These are close to needing a major capital investment in the Gulf of Mexico; the merged group might prefer to sell them instead. There is persistent talk they could be merged with Woodside, whose acquisition by Shell was blocked by Australian politicians. In the meantime, most economists forecast an easing of the oil price in the coming year, which will make it difficult for BHP Billiton to raise group earnings overall. There is little hope for much more than the promised £190m of synergies.

In the immediate future, investors should watch for an uptick in confidence from US industry. Before the early signs of recovery are clear, commodity prices are unlikely to rebound, and mining stocks look vulnerable to disappointing economic news. Billiton shares, at 348p, are on 15 times this year's forecast earnings. It is wrong to hope its inflated size will lead automatically to a re-rating. It is too soon to buy.

Fitness First

"I'm going to join a gym." Always easy to say, but people are increasingly spending the time and money to get themselves into shape. In the UK alone in the last six months, more than 20,000 people have taken a membership at a Fitness First health club.

That helped the group produce another smashing set of interim results yesterday. Underlying profits for the half-year to April were up 60 per cent to £8m, on turnover that was boosted 150 per cent to £60.7m.

Fitness First is pouring cash into expansion in the UK and, even more enthusiastically, overseas. The group operates 164 health clubs, up from 93 a year ago, and expects to open 70 to 80 every year for the foreseeable future, establishing an empire of identikit clubs spanning continental Europe and into Asia and Australia. Early signals from the new openings are uniformly positive.

The chief executive, Michael Balfour, promises to go to the banks rather than to shareholders for his next tranche of investment capital. He is halfway through a £100m overdraft, spending £75m a year on new clubs. The group is generating cash at the rate of £35m a year, but that is growing fast. Still, no sign of a dividend for shareholders from this stock.

One important set of numbers, not mentioned in the publicly available results but passed to analysts at a presentation, shows like-for-like revenues up 7.5 per cent in the UK and 10 per cent in Germany. These growth rates will become more significant as the two markets mature.

The big worry for Fitness First is that memberships will be allowed to lapse and customer numbers will fall if there is any hiccup in consumer spending. As the economy slows, that is no idle threat to the group's giddy rating.

Dresdner Kleinwort Wasserstein was among the brokers upgrading their forecasts for the full year yesterday. It is now reckoning a 75 per cent increase in profits, to £19.6m, putting the stock on a forward price/earnings multiple of 34, after falling 10p to 587.5p yesterday. The rating falls only to 26 times in 2002 and, given the risks, is plenty high enough.

Coffee Republic

The battle between the cappuccinistas is hotting up, and Coffee Republic is finding that making money in the beverage bars game is more difficult than it looks.

Demand is not the problem. There seems to be no quenching the thirst for expensive coffee among UK consumers, and the number of coffee bars are expected to double by 2003.

Coffee Republic, already the third-largest coffee chain after Starbucks and Costa Coffee, plans to play a big part of this expansion and has £7.2m of cash to fund expansion, despite a pre-tax loss of £2.2m in the year to 31 March.

But grabbing market share is becoming increasingly difficult, and competition for prime locations has led to spiralling rents. Overpaying for property is not to be relished when the economy is slowing.

Coffee Republic has actually scaled back its expansion plans and focused more on standardising its products. It has upgraded its management and is now being led by Peter Morris, the former boss of Walt Disney in the UK. Teather & Greenwood estimated that the first profits are two years away, and the shares, down 0.75p to 18p yesterday, have yet to adjust to lower earnings expectations. There is still nowhere to get a cheap coffee in the City.