Investment Column: France paints Kalon into corner

Mike Hennessey has done a decent job since taking the reins at Kalon in the late 1980s. From a small paint and wallpaper group valued at around pounds 22m, it has grown into Europe's second-largest maker of decorative paints. But the deal that transformed the group last year is looking increasingly ill-timed. The pounds 330m takeover of Euridep, the paint operations of French oil group Total, has run into a slowing French economy, made worse by a government struggling desperately to meet its Maastricht public spending criteria.

Yesterday's half-year figures to June bore the scars. Group profits soared 69 per cent to pounds 19.6m but most of the boost came from including Euridep for a full six months. In fact, underlying figures from the French operations were disappointing, growing from pounds 5.4m to just pounds 7.9m, despite the addition of pounds 100m to turnover.

Kalon faces a pincer movement in France. Although it squeezed cost savings of around pounds 3.9m from the merger in the first half, including pounds 2.1m in France, another pounds 4m has been put on hold while the French courts decide on the legality of the group's rationalisation plans. Including the UK, where the merger of Euridep's Johnstone's Paints and Manders businesses with Kalon is well up to speed, total merger benefits will still top the original forecast of pounds 10m in a full year. But the expected further progress could be extended well into 1997.

Just as serious is the external environment across the Channel. Kalon reckons an unexpected 5 per cent dip in the French paints market cost it pounds 5m in the first half and there is not much light at the end of the tunnel. With the unemployment rate at over 12 per cent, consumer spending remains subdued.

It was hardly surprising then that analysts were slicing profits forecasts from pounds 47m to around pounds 35m yesterday. But the damage to the shares was limited, with the price falling 8p to 125p.

There are reasons to be cheerful at Kalon. It has reversed a three-year decline in market share at Euridep, whose brands have strong market positions. There is no reason Mr Hennessey should not repeat the success of Novodec, the biggest private label paint maker in France acquired in 1993. Margins there have been built to 12 per cent, four times the Euridep level.

Meanwhile, there are grounds for some optimism in the UK. Helped by lower raw material costs, Kalon raised UK profits from pounds 6.1m to pounds 8.2m while weeding out parts of the unprofitable Johnstone's and Manders business. And a 7 per cent fall in volumes shows signs of bottoming out, at least in the retail market. July was the best month of the year so far and August is going well. Overseas beyond France, interesting operations are emerging in Hungary, where Kalon's market-leading position helped it to raise profits a fifth, and in Spain, where profits rose 56 per cent. The potential is there, but, on a forward rating of 20, the shares are up with events.