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Why Sainsbury won't disappoint

Keep the faith in API despite its setback; Buy on weakness at HIT Entertainment

Stephen Foley
Tuesday 07 October 2003 00:00 BST
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J Sainsbury does not suffer from the same weaknesses as Safeway. It has a stronger brand, scores better on a number of dimensions of competition, and we believe therefore that its currently relatively poor performance is capable of significant improvement.

This is the damning aside in the Competition Commission's report on the Safeway bid battle, another stick with which to beat Sainsbury and its chief executive, Sir Peter Davis. It encapsulates the disappointment that Sainsbury is still losing customers and sales despite the hopes aroused at Sir Peter's appointment in 2000 and despite his pouring money into store refits and new warehouses.

But might it not also encapsulate the possibility, even probability, of a recovery? Asda was in crisis at the start of the Nineties but was turned around under Archie Norman. More recently, many said Marks & Spencer was doomed to decline into a minor lingerie chain.

Sir Peter argues that he has laid the foundations - all that is needed now is time. Analysts were yesterday reporting back from a visit to see the new range of homewares that Sainsbury is rolling out in a bid to compete with the non-food offerings of its bigger rivals, Asda and Tesco. The analysts also saw a new giant warehouse which is finally bringing Sainsbury's distribution system up to the speed of its rivals.

It is playing catch up, then, and doesn't have the balance sheet muscle to compete on price. Savacentres are being switched to a more upmarket branding, but the company still faces both ways in the "value v quality" positioning dilemma.

Sales figures due later this week are expected to show a fall, compared with rises of 7 per cent at Tesco and 10 per cent at Morrisons. The brand positioning is clearly not yet right. But you don't have to be a cheerleader for Sir Peter to bet on Sainsbury shares and at least one analyst is recommending buying the shares in anticipation of a new broom when Sir Peter is kicked upstairs to chairman next year.

The share price is well backed by Sainsbury's property assets and the dividend is an enticing 6 per cent. Now seems a good moment for contrarians to take their punt.

Keep the faith in API despite its setback

API, the packaging company which The Independent made one of its share tips of the year, suffered a setback on its road to recovery yesterday.

The group operates in the viciously competitive market supplying packaging and labels for drinks, cigarettes and food companies. A string of acquisitions in the Nineties left it hobbled by debt and badly integrated. Now, it is trying to focus on its higher margin specialism in printing on foil, laminates and metallic paper.

The current management, which has been in place two-and-a-half years, conceded yesterday that it has reached a "glass ceiling" in terms of the cashflow benefits of plant closures and other efficiency improvements. It is embarking next on a swath of cuts in middle management which should make up in the coming year for the disappointing trading that ended the last 12 months.

Those disappointments, disclosed yesterday, included the effect of the Sars virus on its Chinese plant and the loss of a big US customer. It means a loss for the year ended 30 September instead of return to profit (and the pre-tax, pre-goodwill level) and only £2m instead of £4m profit next time.

The shares were knocked 10p yesterday to 78.5p. That is basically where they started the year, and fair given the setback It is worth keeping the faith, since the strong cashflows have taken debt right down. Also, management has not abandoned its aim of reshaping the group as one making £160m-£180m turnover and profit of £12m-plus within three years. This is still achievable since the new restructuring will integrate currently separate businesses which have in effect the same customer bases. Buy.

Buy on weakness at HIT Entertainment

Hit Entertainment is the children's character company on track to become a mini-Disney. Its international megastars already include Bob the Builder, Barney the dinosaur and Pingu.

Yesterday's results showed that it has done a good job integrating the £137m acquisition of Gullane, which brought Thomas the Tank Engine into the station, too. As a result of the merger, pre-tax profit was up 45 per cent to £39.7m for the year ended 31 July, on turnover 40 per cent better.

The big news is that the Bob the Builder phenomenon has slowed down but the company, possibly with some justification, is making a virtue of this. No single character now provides more than 30 per cent of turnover. As the company gets bigger, over-reliance on the popularity of one property would have been a worrying situation.

The company says that as a result of Bob's "maturity", sales fell in the US and UK by 18.5 per cent, mainly because fewer Bob toys and games were sold. That made for a worldwide decline of 12.5 per cent in the character's revenues (elsewhere sales were up 55 per cent). By comparison, Barney grew 2.5 per cent. The plan seems to be to relaunch Bob, but not for at least a year.

The children's market is growing and specialist channels are proliferating, boosted by digital technology. HIT is also considering investing in a television channel, probably in the US. This could be a sensible move to guarantee an airing for its characters' shows, but it will have to be very careful not to then be shut out by other channels.

HIT shares, up 11p at 246.5p, trade on a multiple of 13 times current year earnings. That's not expensive, given the healthy prospects. Hold for now and, if the shares fall further, get ready to snap them up.

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