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QUALIPORT
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Carburton Street, London – Last October, Bruce and I commented upon "glitch investing". Essentially, it's investing in an inherently strong company that is suffering from temporary problems. Turnarounds, as such, are not the ideal Qualiport type of investment. We'd far prefer to invest in companies firing on all cylinders. Trouble is, companies where everything looks rosy rarely come with an attractive price tag. It's the old Great Company, Bad Stock story. The Qualiport has been keeping an eye on SSL International (LSE: SSL) lately, with a view to a possible glitch investment. The company is currently suffering from various operational difficulties and its share price has taken a battering. However, the strong underlying business makes it a prime candidate for a recovery investment at some point in the future. Here's how SSL matches up to my three points when considering "pitching for the glitch". Know your business Every company can be subject to an operational turnaround. Yet a company's poor products or its poor competitive position will take plenty of management effort to sort out. The glitch investor should only consider companies with eminently solvable problems... The mismanaged franchise type of glitch is my favourite. Find a company that has industry leading products and a great niche, but requires fresh managerial input to get the company back on track. SSL' s business is that of premium healthcare products. The group was originally formed through the merger of Seton Healthcare and Scholl in 1998. The resulting entity then in turn merged with London International a year later. With all the corporate activity of late, it's incredibly difficult to get a genuine handle on SSL's financial performance. The company's accounts are littered with exceptional items and business disposals, with a recent change in financial year-end also complicating matters. However, one issue that is clear -- the company's attractive products. All are market leaders, in areas where price is not the primary consideration for the consumer, and where repeat and recession-proof purchases are prevalent. Group revenues come from a variety of sources: Durex condoms, Scholl footcare products, numerous branded Over The Counter (OTC) treatments, Seton urinary incontinence products, Lyofoam medical dressings, Regent Biogel latex surgical gloves and Marigold rubber gloves. SSL's product line may not have the greatest of organic growth prospects, but it's about as predictable as you can get in terms of consistent demand. Pre-exceptional operating margins of 20%-plus highlight SSL's industry niche to some extent. Product-wise, it's a Qualiport company. But there's a definite whiff of the "mismanaged franchise" about SSL. "Never catch a falling knife" It's a rare company that succumbs to an operating glitch without the need to issue further bad news. Typically, a trading statement will give the initial disappointment, but then subsequent results will further dampen investors' expectations. Investors should always consider this "drip-feeding of bad news" phenomenon before diving in immediately after the first signs of gloom. A company embarking on an ambitious merger strategy always runs the risk of operational and integration problems. SSL fed the (almost inevitable) bad news in the classic drip-by-drip fashion. The group's interim results published in November warned of "capacity constraints" in the condom and surgical glove markets. Stock levels of such items had remained "too high", and combined with other supply problems, sales for the current and subsequent financial years would now be 3% (£20m) below earlier expectations. Alongside the stock problems, SSL also surprised investors by substantially increasing the restructuring costs relating to the Seton Scholl and London International merger. The second dose of bad news came this week. Iain Cater, SSL's Chief Executive and the instigator of the two mergers, was "invited to step down" from his position and left immediately. Monday's announcement also confirmed SSL's Chairman, Stuart Wallis, would leave his post in July, as previously stated. SSL also revealed profits would again be below expectations. Just like buses, profit warnings always seem to come in threes. This looks likely for SSL, as they tagged this paragraph on to the boardroom update: "Additionally, the group intends to re-assess stock in trade, with a view of reducing this to normal commercial levels. The company expects to quantify the effects of this re-assessment when it announces its Preliminary Results in early June 2001." Coupled with the appointment of a new Finance Director earlier this month, a move that usually heralds an overhaul of financial processes, and it's a fair bet that further financial woes will accompany SSL's preliminary numbers. Valuation Counts Even though investors should be mindful that valuation always counts, it's even more the case with companies undergoing temporary problems. A substantial margin of safety needs to be applied, given the prospect that further bad news could just be over the horizon.
Unfortunately, SSL shares are by no means attractively valued at present for would-be glitch investors. Monday's announcement informed investors that the company "considers it likely that [normalised] pre-tax profits for the year [to 31st March 2001] will be in the order of £90m." By my rough calculations, £90m pre-tax profit equates to earnings per share (EPS) of about 36p. Assuming SSL maintains its 12p dividend from last year, then at 441p, the company stands on a forward price to earnings (P/E) ratio of 12.3 and offers a prospective dividend yield of 2.7%. Although growth prospects are limited, the current share price hardly gives a substantial margin of safety. My view of a rough entry price? Well, a P/E of 10 would give SSL a share price of 360p, and a dividend yield of 5% would require a share price of 240p. All things remaining equal, I think I'd only ever consider SSL around the 300p mark. But given that further difficulties are likely to emerge, I suspect I'll have to change that 300p mark at some point. Summary Overall, SSL is a company with a great set of products, but just requires some improved operational and financial management. But with an expectation of more bad news to come, no Chief Executive to steer the company around, plus a share price exhibiting no obvious and immediate value, there's certainly no rush to get involved with SSL at the moment. However, the beauty of any glitch investment in SSL would be that, should the future Chief Executive not sort out the problems, the company could subsequently make an attractive morsel for a larger industry player. The hard part for any boardroom, the establishing of recognised brands and market leadership, has already been done at SSL. All that's needed is management efficiency, which no end of far larger healthcare companies can provide. The Qualiport will keep a watchful eye on developments at SSL. Your turn A poll for Qualiport readers. Should the Qualiport consider "glitch investments"? Click here to vote. Where Next?