MARKET COMMENT
A Trap For The Unwary Investor

By James Carlisle
November 14, 2002

They say that bear markets are characterised by a market that sees 'the glass as half empty', and that effect seemed to be in evidence in today's interims from Invensys (LSE: ISYS). Results at the low end of expectations combined with a disappointing outlook statement are hardly ideal but, at first sight, the fall of 30% or so in the shares looks more than a little hysterical.

This, however, is a classic trap for the unwary investor. Rather than think 'this is an over-reaction, I'll pile in for a bounce', the correct response is to think hard about what's bothering everyone else. If you look and can't find anything, then look again. The market makes its mistakes, but it's rarely entirely irrational. There will always be something and only by finding it can you decide whether it matters or not.

So that's the approach I took with this morning's results from Invensys. The numbers were at the low end of expectations. Not great, but maybe a matter of 5 or 10% off the shares. The outlook for the rest of the year is 'flat at best'; again not great, but maybe worth 5 or 10%. After all, who can really have been expecting much of a pick up? I'm not aware of any seasonality that makes a flat performance so bad, although it's a little hard to say, with numbers that have been a dog's dinner for at least five years.

Perhaps the worst of the figures was the one for free cash flow, which suffered a worrying fall to £9m, from £68m last year, after £81m got sucked into working capital despite the reduced size of the group's operations. The number one reason was increasing stock levels due to worse than expected sales.

On the plus side, the disposal programme is ahead of schedule, bringing net debt down to £1.8b. The pension shortfall is apparently better than expected, although some uncertainty may have spooked investors given that the pension fund is now about three times the size of the operating company. Finally, the company tried to knock any worries about asbestosis on the head.

So what's the big problem? Firstly, the report has a very messy look to it, with the potential for nastiness seemingly coming from all sides. Most importantly, though, investors have been given a stark reminder, nudged along by the weak cash flow, of the real problems at the company. It has a mountain of debt, notwithstanding recent disposals, and its products, mostly comprised off commoditised process equipment, are at the heart of the 'deflation' that everyone keeps talking about.

Sales and profits that won't budge upwards and a large wedge of debt don't make a happy combination. The company will have continue to sell businesses to reduce the debt, but don't imagine that the prices they fetch won't reflect the problems they're in. The market is looking at a glass that's half empty, but that seems reasonable given the way things are going.