The Motley Fool UK: The Daily Fool, 2/6/99

[ Wednesday, 2 June 1999 ]

Market Closed
FTSE 100  6302.20 +52.20 (+0.84%)
FTSE AS   2923.38 +22.52 (+0.78%)

The Market Today

Baker Street, London -- Rolls of thunder and flashes of lightning last night were not just a mere meteorological phenomenon. They were all part of the promotion for today's launch of Lunchtime News. The regular Daily Fool will still be here every day, but from now on, Fools will not need to wait until 7pm to find out what the Motley Fool thinks of the market. Log on at 12:30 and you will find the main stories already in place. Let us know on the Lunchtime Fool message board what you want to read there.

The market today rather ignored this historic occasion. It went up a bit, fuelled by bid rumours and some reasonable results. An encouraging survey by the Confederation of British Industry on retail trends was certainly positive for that struggling part of the economy.

Conquerors

Sainsbury (LSE: SBRY) gained 9p to 389p after announcing a 4% increase in profits last year and 1,100 job cuts. Although sales rose by 5% Ł16.3b, volumes were only up by 0.5%. Profit before tax (PBT) increased by 3.8% to Ł756m. Adjusted earnings per share (EPS) rose by 2.3% to 27.2p. The new plan aims to generate savings of Ł160m and turn sales volume growth positive by the end of the current year.

Also up today was Invensys (LSE: ISYS). This renamed amalgam of BTR and Siebe gained 31p to 316p after it announced its first set of preliminary results in its new form. Group sales were Ł6.550b, up 10.4%, PBT was Ł295m and earnings per share on an adjusted basis were 17.8p. As a result of harmonising the accounting at the two firms, net assets have been reduced by Ł698 million. This brings operating profit in the year to 31 March 1999 down Ł54 million. It makes you wonder how two sets of accountants can come up with such different numbers. It plays havoc with all the valuation ratios.

Currently 48% of Invensys revenues come from North America, 47% of its employees work there and over 35% of its shares are now owned or managed by North American investors, so the company intends to seek a listing on the New York Stock Exchange. Furthermore, because the disposal programme focus mostly on the engineering businesses, the company expects to be re-classified from the Engineering to the Electronic sector. By coincidence, the market thinks companies in the Engineering sector are worth 15.34 times earnings. Electronic companies are valued at 23 times annual earnings. The company also intends to return capital of Ł1b.

Signet (LSE: SIG) gained 2p to 53p after reporting first quarter results. The world's largest specialist retail jeweller said PBT was Ł9.5m for the period, an increase of 42% and EPS were 0.4p, up 300%. Sales for the period were Ł224m, compared to Ł198m last year, reflecting a like-for-like sales increase of 8.0% and a total sales increase of 13.2%. Almost all the gain was in the US, where sales were up 20% compared with a fall of 3% in the UK. The positive statement that accompanied the results was enough to get one broker to raise his recommendation, helping the shares move up.

AstraZeneca (LSE: AZN) celebrated its first official operating day as a unified company by gaining 3p to 244p. At a ceremony in the US, the company's chief executive said it would expand its basic research operation in the United States even as 6,000 jobs are cut to achieve a targeted $1.1 billion in cost reductions. However, the company will build up its presence in the US for basic research, especially in central nervous system diseases.

Vanquished

Character Group (LSE: CCT) continued its decline after yesterday's results and lost another 4p to 372p. Profit taking was also evident in Whitbread (LSE: WTB), which dropped 30p to 1100p as the market gave further consideration to its proposed deal with Allied Domecq (LSE: ALLD), up 3p to 621p.

Racal (LSE: RCAL) suffered a decline of 4p to 382p after reporting results -- PBT was Ł81m, compared with a loss of Ł205m last year, and EPS were 23.09p. Turnover from continuing operations for the year to 31 March was Ł983m, compared with Ł922m last year. In Telecommunications Services, revenue growth remained disappointing. The company said it was undertaking a fundamental reorganisation in order to implement a strategy to deliver strong revenue growth from the fast growing commercial and carrier services markets. A flotation remains its preferred option.

Bank of Scotland (LSE: BSCT) was weak on concerns over the group's links with controversial US preacher and businessman Pat Robertson. The stock fell 35p to 850p. Robertson was reported as describing Scotland as a nation that had turned its back on Christianity. In March the bank announced it had formed a joint venture with Robertson to operate a direct banking operation in the United States. Robertson would chair the new telephone and Internet-based retail bank.

Fool's Eye View -- Are We Inflating or Deflating?

The news this morning from the Halifax (LSE: HFX) that British house price inflation has jumped to its highest rate for more than six months in May is good news for most people.

The Halifax said that house prices rose a seasonally adjusted 2.1 percent on the month to give a year-on-year rise of 5.7 percent, up from 3.7 percent in April and the highest rate since last October. It said the recent recovery in British house prices had been sooner and stronger than expected.

In a great illustration of the art of forecasting, it also said that because of this strength it had revised its forecast for the annual rate of house price inflation in the final quarter of 1999 from 4% to 6%. As reasons for this strength, the Halifax said the recovery in the housing market was due to improved consumer confidence and the lowest mortgage rates for more than 30 years. But despite that and the "highly favourable" affordability position, the expected slow recovery in the overall economy over the rest of the year meant a housing market boom was unlikely, it added.

Higher house prices are good if you have already bought a house. Even better if you are buying it on a mortgage -- then gearing kicks in to give a magnified effect on the equity you have contributed. Say you bought a Ł100,000 house last year and borrowed 90% of the funds required. The total value of the house is now Ł105,700, but your mortgage is still only Ł90,000. Your equity is therefore now worth Ł15,700, a very juicy 57% gain. If you had been lucky enough to buy this house outright with cash, your gain would have only been 5.7%. That, in fact, would have still been a smart move, because the FT All-Share Index is up only 3.9% over this period -- although you would have got another 2.35% return from dividends, taking your total return to 6.29%. This is a slightly better than the housing market, and with much lower dealing costs. Now if only someone would lend me Ł90,000 to invest in an index tracker fund.

Housing is attractive as an investment because it is possible to buy it on borrowed money, something you cannot do with equities. In the example above, the investor would have been well advised to keep his money in the market and borrow the funds to buy the house. This gives his Ł10,000 equity in the house a much higher return. However, we can see from these numbers that the differences are small. A slight change in the returns from both asset classes would have changed the picture a lot.

What is strange in today's economic environment is that only two types of assets, houses and companies, seem to be experiencing rising prices.

The reality of weak or falling prices for most everyday products is brought home to us again today. Results from Sainsbury show the company, like just about every retailer, reporting minimal sales growth. Last year it was 4.4%, which is only a few points more than GDP growth. Marks & Spencer (LSE: MKS) last week recorded a 0.23% decline in sales, although that company has had particular problems.

Elsewhere we see oil prices slipping back below $14 a barrel and gold at a 20 year low, now trading at $267 an ounce. So there is no price pressure from commodities. We can see price weakness in other areas, too. Airline seats have never been cheaper, and car prices are static. In fact, if you compare the gizmos you get on a car now with those of even 10 years ago, they offer far better value.

So why are the prices of the companies going up if the products themselves are not?

There are three reasons, I think.

Firstly, the companies are more efficient. They have cut costs by becoming more automated and doing fewer unprofitable activities in-house. In short, they are using their capital more effectively, so every pound invested is worth more.

The second reason is that more money is available to buy equities. People are richer now and have more disposable income. The availability of tax-free vehicles like ISAs and PEPs has persuaded people to use equities for long-term savings rather than building societies. More money going into shares pushes the prices up. According to Proshare, 27% of the UK population now own shares directly. That is still a long way behind the US, where the figure is 40%.

A third and final reason is that there have been few new issues recently. Unlike the eighties, when large-scale privatisations were a regular occurrence, there have been no government sell-offs in the 2 years since (New) Labour was elected. Moreover, the private sector itself has been sparing with its paper. Thomas Cook was the last big issue. More common has been the shrinkage of equity capital through buybacks and takeovers. Both features, of course, are a result of the low interest rates now prevailing, which make debt cheaper. Interest rates are low because inflation is low.

So this paradox of cheaper goods but more expensive companies is explicable. Although share prices seem expensive to some us, it looks as if they will get more expensive. If inflation and interest rates stay low, and the percentage of the UK population holding shares moves to levels seen in the US, then the laws of supply and demand must apply.

And Finally...