QUALIPORT
Invest in Management Experience

By Maynard Paton (TMFMayn)
October 25, 2001

Carburton Street, London -- Qualiport watch list member Renishaw (LSE: RSW) issued a profit warning last week. The specialist engineer (reviewed here) stated:

"The current year has not started well with first quarter sales being approximately 10% less than the corresponding period last year... If these present difficult trading conditions and world economic uncertainties continue throughout the financial year then our full-year profits will be below those of last year's record results by a very significant amount."

It's not too surprising to see Renishaw deliver that sort of statement, given:

* About 50% of group sales and profits are generated in the US and Germany, two countries whose economies are not exactly in the best of health;

* Renishaw stated within its latest annual results that sales in the final quarter of trading, while higher than that of the previous year, had been below expectations, and;

* Renishaw's latest annual results highlighted a large build-up of stocks. In the year ending June 2001, the company's stockpile rose 46% to £22.1m while sales rose just 19% to £125.3m. The stock increase was quite out of character with past Renishaw results and implied customers were keeping their wallets shut.

(That said, Renishaw did state in its 2001 annual report: "We have aimed to minimise the risk of any disruption to the supply of products to our customers... This has led to a planned increase in specific items of stock". But I'm not entirely convinced.)

Revisit tough times

When companies are trading in a tough environment, it's worth revisiting how they performed in the past. That's especially true of companies like Renishaw, where the line of business hasn't changed dramatically over years. Looking back to the early nineties recession then, it would seem Renishaw is quite sensitive to the vagaries of the global economy.

Year to 30th June         1991    1992    1993    1994    1995

Turnover (£m)             45.7    44.0    48.0    50.9    66.7
Operating Profit (£m)      8.3     6.7     4.9     7.2    11.8

Operating Margin (%)      18.1    15.2    10.3    14.1    18.9

Earnings per share (p)    10.8     8.8     6.9     8.1    13.4
Dividend per share (p)     4.0     4.4     4.4     4.7     5.3

Noting that operating margins fell significantly between 1991 and 1993, will there be a comparable drop in the near future? Assuming margins do fall on a similar scale, investors could see Renishaw's present operating margin of 22% drop to something like the 13% level in the near future.

Indeed, if turnover remains at £125.3m and we assume that profits continue to be taxed at last year's 25% rate, and excluding interest received from the company's £39m cash hoard, the above margin deterioration would imply "operational" earnings per share (EPS) of 16.8p. If we then subtract the company's 54p per share cash pile from today's 381p Renishaw share price, an "operational" price to earnings (P/E) ratio of 19 is produced.

Overall, I'm in no rush to invest in Renishaw at the moment. Although the company is still fundamentally attractive for long-term investors, I don't sense much in the way of obvious and immediate value at the moment. I'd far rather wait for the next set of results and see how the land really lies before making any further valuation judgement.

Management

One interesting point from Renishaw's update was the following statement made by Sir David McMurtry, the company's Chairman and Chief Executive:

"We have experienced economic difficulties before; we intend to emerge from the present situation as a stronger company."

A comforting factor when investing for the long-term is having your company run by management who have seen it all before. With Sir David's thirty years at the helm of Renishaw, a period encompassing a handful of recoveries from past "economic difficulties", shareholders ought to put their faith in his "stronger company" intention. Certainly investors should put more belief into old hands like McMurtry and his words, rather than those "new economy" bosses who are currently experiencing their first downturn in a boardroom.

With that in mind, it's worth investigating the "prime movers" at each of the Qualiport's watch list companies and highlight their time in charge.

Company                  Prime Mover          Year started
                                           As boss   At company            

Allied Domecq            Philip Bowman       1999       1998
Carpetright              Lord Harris         1988       1988
Emap                     Robin Miller        1985*      1965
Halma                    Stephen O'Shea      1995       1983
Games Workshop           Tom Kirby           1991*      1986
Imperial Tobacco         Gareth Davies       1996       1972
Johnston Press           Tim Bowdler         1997       1994      
Latchways                David Hearson       1995       1995
Lloyds TSB               Peter Ellwood       1997       1989
London Stock Exchange    Clara Furse         2001       2001
Metal Bulletin           Tom Hempenstall     1992       1967
PizzaExpress             David Page          1997       1972
Renishaw                 Sir David McMurtry  1973       1973
SSL International        Brian Buchan        2001       2001
Ulster Television        John McCann         1999       1983
Ultraframe               John Lancaster      1983       1983

(* -- includes a 2-year "sabbatical")

Using some subjectivity in judging the sensitivity of each business to management talent and the economic climate, I'd say only Latchways (LSE: LTC) could give cause for concern in troubled times. Before joining the firm after the last recession, Managing Director David Hearson had a long spell at IBM (NYSE: IBM), a company not exactly renowned for selling safety equipment.

And of the others, there are three company bosses who have yet to prove anything at their current firm. But Brian Buchan of SSL International (LSE: SSL) had a 25-year stint at Proctor & Gamble (NYSE: PG) before joining the troubled healthcare firm, while Philip Bowman of Allied Domecq (LSE: ALLD) spent the early 1990s in the boardroom of Bass. Furthermore, London Stock Exchange (LSE: LSE) boss Clara Furse has in her time been a managing director of Union Bank of Switzerland (NYSE: UBS) and the Chief Executive of Credit Lyonnais Rouse Ltd.

Indeed, the talents of Clara Furse and Philip Bowman will be in the spotlight next week. The London Stock Exchange is currently in the race to buy LIFFE (the London futures exchange), a development that will be covered by the Qualiport on Monday. And on Tuesday, Bowman presents Allied Domecq's full-year results, which will be reviewed on Thursday.

More: The basics of Great Management Investing | Yet more Great Management

The author owns shares in Carpetright, Games Workshop, Johnston Press and Latchways.