Shell high-octane rating overdone

The Investment Column

Judged against Royal Dutch Shell's exceptional performance in the first quarter of 1996, its results for the first three months of this year were respectable enough. Current cost net income came in flat at pounds 1.54bn - bang in the middle of analysts' forecasts. What spooked the market, however, was Shell's downbeat assessment of prospects for the rest of the year.

Bearish commentators have been warning for some time that we should expect a substantial weakening in crude prices and Shell has said nothing to contradict that impression. Prices have been falling steadily since the start of the year, registering an average of $21.60 for the quarter.

The picture is one of a continuing decline in prices and pressure on refining margins against a background of rising output in Opec and non- Opec areas. This is likely to result in production outstripping demand, leading to rising inventories.

Add in a strong pound, which held back current cost earnings in the first quarter by 7 per cent, and the outlook is not all that rosy for any of the big oil companies.

Higher exploration and production earnings helped offset increased corporate charges and a fall in earnings from refining and marketing operations in the first quarter.

Shell also managed a modest improvement in chemicals in the first three months but this was only achieved through on-going cost reductions whereas margins weakened. The improvement may stretch into the second quarter but thereafter much depends on Shell's ability to recover the increase in cracker prices by raising the price of derivative products.

With oil and gas production likely to keep growing at around 7 per cent a year, Shell has the scope to complement this strong upstream growth with rationalisation benefits elsewhere, notably chemicals.

However, falling crude prices this year could hold back dollar income. Taken together with the strength of sterling and guilder weakness this could translate into a decline in earnings for the year in domestic currency terms.

Shell's growth prospects are no more than average for the sector - reflected in the decline in first-quarter capital expenditure and exploration costs.

Meanwhile Shell's return on capital employed, at 11.8 per cent for the year to the end of March, continues to lag behind its peers.

Taken as a whole, Shell remains on a high-octane rating. The boost to the share price that came with the news earlier this year of a stock split and capitalisation issue has merely left it even more vulnerable to a rerating. Shell is overvalued relative to BP by as much as 25 per cent, making BP a better bet given its growth prospects and higher returns on capital.

Assuming Shell group profits of pounds 5.1bn this year rising to pounds 5.6bn in 1998, the shares, down 9p at 1,081p, are on a forward multiple of 19 times falling to 17.7. High enough.

Barr's cash pile could reach pounds 35m

Barr & Wallace Arnold Trust's decision to placate its workforce by inviting offers for its coach holidays division rather than simply selling it to rival Shearings really makes little difference as far as the remaining operations are concerned. Whether the business is sold to Shearings, its management or a third party, the company becomes a pure motor distributor with a cash pile of maybe pounds 35m to hand back to shareholders or invest in the rump car activities.

Whether Barr is right to dispose of the coach activities, and so give up a useful counter-balance to its cyclical car sales operations, is a moot point. The company argues that it is misunderstood by the City because of its two diverse activities, which has a grain of truth in it, but there are plenty of motor businesses with other interests - Cowie's buses and Henlys' coach manufacture, for example - to suggest that the problem is not insuperable.

But the decision has been made, and the Office of Fair Trading seems happy to countenance the concentration of power represented by a merger of former Rank division Shearings and the "Wally Buses", so all shareholders can hope for is a sensible price.

Their attention will now turn to how Barr's motor dealing operations will fare in a fast-changing and consolidating business.

Arguably the current trend towards big multiple-franchise dealerships acts in favour of the larger players such as Pendragon and Reg Vardy at the expense of smaller operators such as Barr. But there is a plausible counter-argument that the large manufacturers are unwilling to hand over too much power to dealers with clout, leaving a useful niche for regional players.

Barr's supporters point furthermore to its high margins, good management team and tight geographical concentration which allows it to dominate the markets where it is strong such as Ford around Glasgow. If it chooses to spend its pounds 35m windfall on expanding its dealerships, analysts believe it will make a decent fist of it.

Despite that, Barr's shares, up 8.5p to 258.5p yesterday, trade on only about 10 times expected earnings for this year, a significant discount to the rest of the market.

A dividend this year of 12.5p a share, implying a gross yield of 6 per cent, provides some degree of comfort. Good value.

Etam dives deeper into the red

Etam, the womenswear chain, plunged deeper into the red in the year to 25 January, as price discounting took its toll of static volumes. Turnover fell by 7 per cent to pounds 187m while losses mushroomed to pounds 5.37m, compared with a modest profit of pounds 150,000 the year before.

Etam's chairman, Stanley Lewis, claims the sales decline was concentrated in the first half-year and steadied in the second half, while the proportion of sales at full prices has rebounded to over 80 per cent and justifies the merchandise and trading strategies of the group.

Up to a point. Turnover in the first half was down 11 per cent on the previous first half. In the second half it was down only 2 per cent on the first half and 2.5 per cent down on the second half of the previous year.

But the seasonal upturn in profits in the second half was much more muted this year, and at pounds 390,000 was well down on the pounds 4m in the previous year.

Even after allowing for the pounds 2.5m of strategic expenditure on the first phase of a brand relaunch and for spending on information technology in the latest second half, there is no evidence of a real recovery in Etam's profits.

In the first 13 weeks of the current trading year, full-price sales were up 6 per cent and like-for-like sales rose 2 per cent, but the City is not convinced.

Etam's sales should be improving faster given the recent kind weather, more costs are in the pipeline and analysts who felt the group could break even by the end of the current year are now forecasting losses of around pounds 2.5m.

The shares fell 8.5p to 125p, their lowest level since the recession of 1990, and the controlling shareholders, based in South Africa, show no obvious signs of impatience. There is no obvious case to hold the shares, still less to buy.