Qualiport

[ Wednesday, 02 June 1999 ]

J Sainsbury and M&S, Brothers?

By Bruce Jackson (TMF Googly)

Kilburn, London -- Just to get things up to speed on the admin side, the sale of Marks & Spencer (LSE: MKS) was completed last Thursday. The price obtained of 391.5p was of course near to the bottom point the shares have traded over the last 5 days, but that's true to Qualiport form. Anyway, I wasn't going to worry about a few pence either way, as over the long term it will be insignificant. Also added to the cash pile was £18.88, the final Independent Insurance (LSE: IIG) dividend. Next week we should receive the Unilever (LSE: ULVR) special dividend, and at the same time we will adjust for the share consolidation. That should see us with almost £3400 in the bank, ready and waiting to be reinvested into the market.

Despite the M&S sale, the Qualiport strategy remains one of buying and holding shares in great companies. Is M&S a great company? It certainly was a great company, but has clearly not been performing like a great company in the past 12-18 months. Great companies can turn things around, and this will be the test for M&S.

However, on the day that J Sainsbury (LSE: SBRY) reported results, accompanied by the comment from its chief executive that "The performance of Sainsbury's Supermarkets is not acceptable," one cannot help but draw analogies between the two companies. Profit growth at the former clear supermarket leader has stalled to such an extent that between 1994 and 1999, earnings per share (EPS) growth was 0.0%. The share price hit a high of 477p in 1995 and now stands at 388.75p. Who would have thought that Sainsbury would lose the market lead, especially to upstart pile 'em high, sell 'em cheap competitor Tesco (LSE: TSCO)? And, even more surprisingly, who would have thought that Tesco would increase that lead as the years rolled by?

Sainsbury today announced a wide-ranging restructuring, aimed at increasing like-for-like sales and recapturing market share. This includes cutting over 1,600 jobs in an effort to save £160m over a three-year period. M&S is going through a similar job and cost cutting phase as it, too, attempts to regain market share. However, like Sainsbury, there's no guarantee these actions will see M&S regain that lost market share. On the clothing side, competitors such as Next (LSE: NXT) and The Gap will not rest on their laurels. On the food side, the four big supermarket chains have caught up to M&S in terms of selection and quality of "heat and eat" type products. From experience, I now do my food shopping at Sainsbury, choosing it ahead of M&S and Safeway (LSE: SFW). Last year, it was M&S only for me.

Adding these qualitative factors to my quantitative analysis, it all adds up to doom and gloom as far as I'm concerned. However, as I've said on the message boards, this is only my opinion. I could well be wrong -- it's happened once or twice in the past! There's always going to be plenty of disagreement regarding the future of M&S, because we've all got an opinion on it.

Yesterday, a couple of brokers released conflicting research notes. West LB, who are sellers of M&S shares, said, "we believe the picture painted by management was way too optimistic and this will make it much more difficult for the share price when consensus forecasts reflect the reality." On the other hand, Warburg Dillon Read was said to have raised its share price target to 440p from 400p. Over what period of time that refers to is anyone's guess, but the Wise are renowned for thinking in terms of months rather than years. As for the Qualiport, it has voted with its feet. Bye bye, M&S.

Yesterday was results day from our media company, EMAP (LSE: EMA). Yet again, it was another solid yet unspectacular performance from this most consistent of companies.

Here's what I saw as the salient bits of the results release.

EMAP knows the magazine business very well, as it ought to, since that's its core business. For example, EMAP cuts back on brand promotional expenditure when circulation levels fall. It's no use throwing money at something when the public is just not buying it, especially because of gradually worsening economic conditions.

The big US Petersen acquisition is living up to early expectations. A company that is traditionally conservative with its outlook statements said, "Petersen [is] such an exciting growth opportunity." Analysts have often questioned the high price paid by EMAP for Petersen, but the company clearly thinks this will be money well spent. In the years to come, this could be seen as a cheap entry vehicle into the lucrative US market.

Radio growth continues apace, with underlying sales up 11% and profits up 15%. Advertisers are increasingly being attracted to this medium because of its power and price.

Is EMAP an Internet company? This division is losing money, so it must be. EMAP has interests in travel, pop, radio and magazine sites, including www.fhm.co.uk, with 10 million impressions per month. You can check them all out from the company's home page at www.emap.com

Operating margin increased yet again, up from 18.4% to 19.5%. It stood at 12.1% in 1995.

The company continues to concentrate on its cash generation, with 99% of accounting operating profits converted into cash. At the year end, EMAP was in debt to the tune of £686m but still maintains it has sufficient firepower for bolt-on acquisitions should the opportunity arise.

I haven't been able to do my proper current valuation numbers because of the lack of a full balance sheet. Also, EMAP has now capitalised some (or all) of the previously written off goodwill on acquisition, and this has resulted in a large amortisation charge being deducted from profits. This in itself shouldn't change the valuation of the company, because the amortisation charge is non-cash. The net effect, however, is to reduce reported EPS and hence increase the price to earnings ratio (P/E). The market is sensibly valuing the company on a multiple of its cash flows rather than reported earnings. As a rough calculation, I see EMAP trading at or about its intrinsic value, making it neither cheap nor expensive. But more work will be required on this when I get the annual report in the middle of the month.

So there we have it. Was it Buffett who said it's better to be certain of a good result than hopeful of a great one? EMAP could just fit that bill.

The share price of former Qualiport star Rentokil Initial (LSE: RTO) has been firm since it briefly hit 235p last week. Rumours that it may be interested in buying part or all of Williams (LSE: WLMS) have been circulating the market. Williams is best known for its security and fire protection products. Naturally, we're taking those rumours with a pinch of salt. In any case, if Rentokil did announce a bid for the company, Rentokil's share price would most likely fall. Any acquisition of this size (approximately £4 billion, including assumed debt) would have to be funded by a rights issue, and the City may not to too keen to back this, given Rentokil's recent sort-of-profit-warning. We're not going to get worked up over this.

Apart from me, has anyone else noticed that Dell Computer Corporation's (Nasdaq: DELL) has now fallen from a high of $54 to $33, a 39% drop, in the space of just 4 months? That's also now 26% below our late January buy price of $44.63. Almost since the day we bought Dell, technology and high P/E shares have been on the decline. Also, the market has been worried about Dell's slowdown to a mere 40% year-on-year growth. It has been used to this company thumping the market's quarterly profit estimates and consistently growing above 50% year-on year.

Finally, a lowering of the first quarter gross margin had analysts worrying about the extreme pricing pressure in the sector. Remember the two factors that traditionally drive a market -- fear and greed? Dell's share price is currently subject to the former. The good news for shareholders is that the company is still growing nicely, thank you very much. This share price weakness may give us an opportunity to top up on our Dell holding. I'm off to the valuation drawing board.

Please feel welcome to keep feeding back comments to the Qualiport message board. I'll be back next week -- it's Rob again on Friday.

Company  Change    Bid
DELL   -$1.30   $33.00
EMA     +0.13    13.15
IIG     +0.06     2.93
MSY     -0.14     5.03
PIZ     +0.05     9.20
RTO     +0.02     2.65
ULVR    +0.08     5.50

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