Qualiport

Are WPP Group Qualiwatch material?

By Bruce Jackson (TMF Googly)

Melbourne, Australia -- As you're probably aware, Qualiwatch company Glaxo Wellcome (GLXO) released their 1998 results on Thursday morning. Because of the time difference down here, and thanks to local monopoly (although not for too much longer) telecoms company Telstra's continued inability to run a new telephone line into a house, I'm writing this report without having seen any reaction to Glaxo's results. All I've got is the raw data as released by the company.

At this stage, I haven't seen any media coverage and, importantly, don't know what the stock market's reaction was. This is actually a good thing, as it allows me to objectively analyse the numbers without having the feeling that if the share price went up the results must have been good, and vice versa. Admittedly it would have been good have read further comments and interviews from the company themselves, but it's not essential, because in theory Glaxo have said everything they wanted to say in their comprehensive annual results release.

My initial gut feeling was that the results were good. It looks like Glaxo exceeded market expectations, and I'm guessing the market marked the shares higher in early trading. [Ed. Note: Glaxo shares gained 21p to 2014p Thursday.] Sales excluding Zantac, the blockbuster anti-ulcer drug that has now gone off-patent, increased by 13% in constant exchange rate (CER) terms. If you take out the other big product, anti-herpes drug Zovirax, which has also recently gone off-patent, CER sales increased 17%. In total, sales were about 5% higher than I'd anticipated.

The impressive drug pipeline, which includes five new products currently in the process of being launched, will fuel double digit sales and earnings growth in 1999. Looking further ahead, Glaxo are confident that they can "continue to deliver strong, sustainable growth, enabling [the company] to maintain a leadership position in the world pharmaceutical industry."

There's no doubt that this is a quality company. It has many of the attributes we are looking for in a Qualiport company. Virtually the only thing putting me off them is their valuation. As I have commented over the past few reports, I am concerned about Glaxo's cash generation, and yesterday's results did nothing to dispel those concerns. Debtor and stock levels are much higher than last year, the former due to some "speculative wholesaler buying in the USA in December." These are reported as sales in fiscal 1998, but the wholesaler won't pay Glaxo, or actually sell the products, until 1999. What happens if the wholesaler can't sell the products? Were they sold by Glaxo on a sale or return basis? Did Glaxo offer the wholesaler a discount to take delivery of the goods in 1998, therefore artificially boosting sales in that year? I'm not suggesting any sales or accounting skullduggery, but these are things a potential shareholder should be able to feel comfortable about.

There has been a change in accounting policy, whereby Glaxo are now capitalising some software development costs and writing them off against profits over a 5 year period. This has the effect of increasing profits, because previously the costs were charged directly against profits in the year in which they were incurred. 1998 saw some £70 million of cost spread into future years, when the company says the benefit from the expenditures will be derived. Whilst the new treatment may better reflect reality, and the matching of costs with income, let there be no doubting that the reason it was done was to boost reported accounting earnings. It doesn't change the company's net cash position one iota.

Nothing I have seen from yesterday's results has made me materially change my valuation of Glaxo. They will remain on the Qualiwatch list, but we will only consider buying them if the price falls to around 1500p. We will of course review and revise this valuation as time goes by and as the company releases quarterly results. It could be that we never buy shares in this excellent pharmaceutical company, because it always trades at a valuation above ours. That will be a pity, but I just don't feel comfortable buying the shares at current levels. But if the shares fall or the market suffers a short-term correction, having done our homework, we'll be ready to pounce. This is what Qualiwatch is all about.

More Qualiwatch

As a reminder, Vodafone (VOD) is on our list of potential Qualiport purchases. I just need to do some valuation work on them and intend having a first stab at something next week. The acquisition of AirTouch Communications will undoubtedly make this process more difficult, so in the first instance we will look only at a valuation of the existing Vodafone business. There are relatively few opportunities for merger related cost savings, so if we value the two companies separately then add the result together, we won't be too far away from a realistic valuation. Did you know that in the US, the receiver (not caller) pays for the cost of the mobile phone call? Many people therefore keep their mobile phones turned off. Vodafone AirTouch will be keen to change that and in turn increase total usage times.

The other company on my "learn more about" list is Misys (MSY). They are essentially a service company and supply software products to the banking, insurance and healthcare markets. Don't tell anyone, because as a possible potential shareholder I don't want the share price to go up too much, but they have an Internet presence, albeit a quite small one. Screentrade (www.screentrade.com) is part of their Misys Interactive Trading division, and looks to sell insurance products over the Internet.

I'm adding one other company to my "learn more about" list. It's WPP Group (WPP), the worldwide marketing services company. They released their annual 1998 results this week, with EPS up 20%. Flicking through the numbers and commentary, I got a good gut feeling about the company. One long paragraph begins with the words "in order to enhance share owner value..." and goes onto say "as current opportunities for acquisitions at sensible prices are limited, the Company increased the amount available for share buy-backs in the open market to £50 million, when market conditions were appropriate." This is a company that knows where its priorities lie -- with its shareholders.

Operating margins at WPP again increased, up to 12.8%, but the company says there is even more scope for improvement as their major competitors enjoy margins of between 15% and 18%. This is an asset light company, and one that generates cash flow well in excess of their accounting profits. Finally, they see the Internet as providing them with an opportunity to expand their services, and they already have US$120m of Internet related billings.

Have a great weekend, Fools. Have you seen our groovy new online portfolio facility? If you haven't done so already, why don't you register and set up your portfolio, enabling you to track the performance of your shares on a minute by minute basis? Minute by minute? I know that sort of goes against our Foolish buy-and-hold philosophy, but what the heck -- it's fun. Unlike most other portfolio facilities, you can input your buying prices too, so you can easily and quickly see your total profits and losses. Hop to it, and tell all your online buddies about it, too.

Unilever (ULVR) releases results next Tuesday. I'll be hoping for a further improvement in their operating margin and continued strong cash generation. The City will no doubt want to know if the company has any plans to spend its huge cash pile on a big acquisition or give it back to shareholders. We'll cover the results next Wednesday. In the meantime, see you on the Qualiport message board.

                    16/02/99 Close

                   Company   Change    Bid
                    DELL    -$1.00   $88.50 
                    EMA      -0.28    12.15
                    IIG      -0.02     2.28 
                    MKS      -0.03     3.65
                    PIZ      +0.02     7.51 
                    RTO      +0.11     4.48
                    ULVR     -0.07     5.98

Qualiport Stocks

Last Rec'd  Total #  Company   In At    Current   Change
 19/12/97    783       RTO      2.55      4.48     75.7%
 17/04/98    169       EMA     11.85     12.15      2.5%
 04/11/98    245       PIZ      7.93      7.51     (5.2%)
 27/01/99     37       DELL   $89.25    $82.75     (7.3%)
 17/07/98    298       ULVR     6.72      5.98    (11.3%)
 27/10/98    755       IIG      2.58      2.28    (11.6%)
 11/05/98    368       MKS      5.54      3.65    (34.1%)

Last Rec'd  Total #  Company    In At     Value      Change
 19/12/97    783       RTO     2046.53   3507.84   1461.31
 17/04/98    169       EMA     2052.57   2053.35      0.78
 04/11/98    245       PIZ     1966.34   1839.95   (126.39)
 27/01/99     37       DELL    2007.42   1855.61   (151.81)
 27/10/98    755       IIG     1972.64   1721.40   (251.24)
 17/07/98    298       ULVR    2052.54   1782.04   (270.50)
 11/05/98    368       MKS     2054.11   1343.20   (710.91)


Cash:                                  £2,000.18
Current Total :                       £16,103.57

Total Invested:                       £16,184.62
Profit/(Loss) :                         (£ 81.05) 


Value Per Share

                    Day      Month      Year      
Qualiport          0.15%    -2.38%     -4.20%
FTSE 100          -0.06%     3.03%      3.27%
FTSE All Share    -0.11%     3.09%      3.94%

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