Fool's Eye View

[ June 6, 2000 ]

Medical Complications

By Maynard Paton (TMFMayn)

Carburton Street, London -- When I write features covering the Foolish Qualiport real money portfolio, one type of business I always try and look for are the ones that have a "consumer monopoly". Legendary stock-picker Warren Buffett has made billions from canny investments in Coca-Cola (NYSE: KO.) and Gillette (NYSE: G.), both companies deemed by the famous investor to be consumer business franchises.

Looking at the two US examples, they have similarities. Their respective goods dominate their marketplaces, the companies have significant repeat business and, through the power of branding, both companies can consistently exert premium product pricing.

With those features in mind, a few years ago, I had my eye on a company called London International. The group owned and manufactured the Durex brand of condoms. The profile of the condom industry, I guess, is pretty similar to that of Gillette's razor blades. Thus, a highly repetitive, recession proof and premium priced type of purchase handed London International a great set of industry characteristics. But, even with this favourable marketplace, London International still managed to flounder. Last year, London International shareholders were rescued after a profit warning when the group merged with Seton Scholl Healthcare, the enlarged entity becoming SSL International (LSE: SSL).

Recent history

The recent history of SSL is one of acquisitions. After a string of minor purchases to form Seton Healthcare, the company then acquired the ailing Scholl footwear concern in 1998 and the aforementioned London International in 1999. Along the way, SSL has steadily focused on creating a market leading premium healthcare business, disposing of many unbranded or secondary products. Alongside Durex condoms and Scholl shoes, SSL also manufacture a wide range of over-the-counter pharmaceutical products, has involvement in "wound management" and continence care products, as well as manufacturing the more familiar Marigold rubber gloves.

With all the corporate comings and goings over the last few years, SSL's financial results have been clouded by all sorts of "exceptional" complications. The group's annual numbers released today continue the complex reporting trend.

Complicated accounting

Here's how SSL presented the headline figures this morning. Just to confuse things a little further, this year's annual results contain an extra month.

                     13 months to   12 months to
                      31/03/2000     28/02/1999

Turnover (£m)            704.7         631.0
Operating profit (£m)    135.8         100.0
Profit before tax
and exceptionals (£m)    116.6          86.9

Adjusted earnings
per share (p)             47.9          35.1

From these figures, everything looks fine. But SSL have stepped up a gear in terms of exceptional charges, a now regular accounting feature on the SSL books. After last year's £54m of one-off charges, SSL have today introduced a whopping £143m exceptional cost that totally overshadows the profits declared today.

SSL do have a great record of acquiring, integrating and generating synergies from acquisitions, with pre-exceptional operating margins having jumped from 15% to 19% in this reported period. But the obvious problem when assessing SSL is trying to decide if these exceptional accounting items are truly "exceptional". SSL has developed a habit of acquiring businesses over the years, and so "post merger integration costs" do become a familiar recurrence.

Investors trying to get a shorthand grip on what actually is happening at SSL would be best to focus on the top line. Underlying sales growth within SSL's "core categories" was 8.1%, with a 6.5% revenue increase reported during the 13 months. In terms of the future, SSL have the key objective of generating 6-8% of like-for-like revenue growth and 15% annual earnings per share growth, with this profit surge being aided by a medium-term operating margin target of 25%.

Three options

Although having a financially enticing set of products, the complicated accounts of SSL are anything but alluring for most private investors. Coupled with only five lines covering "new product development" in today's results statement, it appears a combination of acquisition (sigh) and the difficult challenge of trying to establish its UK products as global powerbrands will be the two main drivers of SSL sales growth.

There are three options for any investor who gets excited about the prospects of SSL and wishes to determine a fair valuation for the group. Some hardy souls could embark on the impossible task of dissecting SSL's recent financial performance, while easier-going investors should wait a year or two until the profit performance becomes a little clearer.

But perhaps the best way forward would be to follow the lead of Mark Lucas and apply a low profit multiple to the anticipated adjusted profits from SSL. A mean forward rating would imply a margin of safety in any SSL purchase, just in case those exceptional items are not entirely exceptional. As Mark rightly comments, "Some sort of safety mechanism is definitely needed when considering any purchase of SSL".

Your feedback to the SSL International discussion board, please.

Related Links

• Fool's Eye View discussion board
• SSL International discussion board
• Great SSL post from Mark Lucas
• What is the Qualiport?