Stock Market Week: New sectors put London into line with Europe

Francesco Guerrera
Monday 05 April 1999 23:02

IT'S ALL change for the stock market sectors. After a first test last Thursday, this week sees the full-blown trial of the biggest reshuffle in the index's classification since 1993.

Red-eyed traders coming back to their desks after the Easter holiday will have to adapt to a completely different stock-market landscape. After months of consultation, FTSE International, the company that runs the index, has decided to respond to investors' requests for a European- style classification with a series of radical reforms. The changes will help pave the way to a pan-European exchange and will enable market players to choose stocks on a sector, rather than on a country, basis.

The main sector groupings will increase from seven to ten to mirror the structure of the FTSE Eurotop, the index of leading European stocks. The most interesting new entry is the Information Technology group, introduced after much prompting from lovers of the high-flying IT stocks, such as Misys and Sage.

The new hi-tech sector will be split into two smaller entities, Hardware and Software. The latter will include an Internet sub-sector, a suitable receptacle for the recent online bubble, although non-pure Internet plays such as the rampaging Dixons will not be included.

The division that is likely to raise most eyebrows occurs in the consumer goods and services sectors. The two groups have been subdivided into cyclical and non-cyclical stocks. Given investors' present aversion to anything that smacks of cyclicality and "boom-and-bust" rollercoasters, several companies will be dismayed at having had the "cyclical" tag slapped on them.

For example, Marks & Spencer will cringe at the idea of being branded "a cyclical service", together with a bunch of leisure and restaurant companies exposed to the vagaries of the economy. The department store chain is, as is every retailer, sensitive to swings in consumer spending, but its recent sales growth has been steady and consistent, this year's setbacks apart. Defining M&S as "cyclical" is also at odds with its status as one of the UK's premier blue chips, which accounts for a sizeable portion of that epitome of stability, the FTSE 100.

In other instances, the cyclical/non-cyclical distinction seems a spurious one. Clothes chains are rightly classified as cyclical stocks, while food retailers - one of the classic defence stocks - are predictably considered non-cyclical.

But what about Tesco, and to a lesser extent Asda, two food sellers that launched a determined drive to enter the clothes market, stocking branded jeans and shirts next to lettuce and tomatoes?

FTSE International seems to have got itself into a bit of a tangle over this cyclicality business. Determining the cyclicality of a stock is an investor's job, and the classification committee would have been better off letting punters and fund managers make up their own minds.

The other important change is the disappearance of the ailing oil exploration and production sector. After seven mixed years, the sector will be folded into the oil and gas group. The beleaguered E&P minnows such as Lasmo and Enterprise will have to compete for investor attention with diversified giants such as BP Amoco and Shell.

The obvious reason for the demise of the exploration sector is to bring the UK into line with the rest of Europe, where there are no E&P groupings left. The key trigger, however, has been the fall in the number and performance of the drillers. When the sector started in late 1993, it included about 15 companies, but corporate activity (remember the takeovers of Goal, Clyde and Hardy?) and the collapsing oil price reduced its components to seven. They now have a combined market value of a mere pounds 3bn, compared to BP Amoco's pounds 101.7bn.

The sector changes are not just for stock market anoraks. Market watchers believe they could influence the valuations of a number of stocks. For a start, the reshuffle will widen the gap between lowly- and highly-rated sectors. According to Steward Breed at Salomon Smith Barney, the new groups' price/earnings ratio relative to the overall market will range from the 60 per cent undervaluation of the battered Diversified Industrials to the astonishing 137 per cent overvaluation of the IT Hardware group.

Individual stocks in reshuffled sectors will also see changes in their ratings relative to peers. British Aerospace, for example, looked an expensive engineer with its 10 per cent premium to other metal bashers. From this week, however, BAe is more like a cheap Aerospace and Defence stock, thanks to its inclusion in the higher-rated new group.

Filtronic, the maker of mobile-phone components, is another going from riches to rags: 30 per cent overvalued in the electronic sector, 45 per cent undervalued in the soaring hardware sector. In the other direction, poor old British Steel is transformed from an underperforming engineer into the most expensive stock in the new Steel & Other Metals group.

Laird, one of the few companies on this week's results schedule, is a test case for classification enthusiasts. The group is in the Auto Parts sector because its core products are car body seals, even though it also makes building tools. Both markets were depressed during the year and Laird's profits are set to have slumped by over 40 per cent to about pounds 40m.

Silentnight heads a pack of small retailers due to report figures. The bed and mattress maker has had a year of two halves, with a strong start wiped out by waning consumer confidence in the fourth quarter. Still, Silentnight should be well tucked in with profits level with last year's pounds 16m.

Moss Bros and Oasis complete the retailers' picture. The former should report a 10 per cent slide in profits to around pounds 17m, while Oasis's numbers will be up by around 25 per cent to pounds 13.3m.

With so few results due this week, economic events provide all the excitement. The Bank of England meets this week and analysts are predicting a rate cut, which could propel the markets to new heights. The European Central Bank comes under the spotlight on Thursday, although economists are more evenly split on the likelihood of the first-ever cut in Euroland rates.

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