QUALIPORT
Should The Qualiport Return To M&S?

By Maynard Paton (TMFMayn)
January 14, 2002

Carburton Street, London -- How often do you revisit the shares you've sold in the past? If your answer is 'never', you could you be making an investment mistake. For instance, how many times have you sold out of a company because you thought it was heading for (more) trouble, only to discover the 'trouble' was a minor glitch and was actually a buying opportunity?

Perhaps it's an emotional or psychological problem? Going back over former portfolio shares can resurrect memories of past stock market woes. Far better to leave your mistakes dead and buried, rather than face up to them by returning to shares previously sold.

During its four-year history, the Qualiport has disposed of seven different companies:

Marks and Spencer (LSE: MKS) (sold May 1999)
Rentokil Initial (LSE: RTO) (sold February 2000)
Unilever (LSE: ULVR) (sold June 2000)
Misys (LSE: MSY) (sold September 2000)
Dell Computer Corporation (Nasdaq: DELL) (sold January 2001)
Independent Insurance (sold February 2001)
MMT Computing (LSE: MMT) (sold August 2001)

Leaving aside Independent Insurance, which went bust after the Qualiport's disposal, is any other former Qualiport share worth revisiting?

MMT Computing

One of the key questions long-term investors should ask of their prospective investments is: "What is the sustainable competitive advantage of the business?"

I should have asked that question when purchasing IT consultancy MMT Computing for the Qualiport. To cut a long story short, MMT's competitive advantage rests with its management. But following recent boardroom upheavals, the current team has yet to show any talent. And whether any superior talent they may possess is sustainable for the long-term is anybody's guess. Revisit MMT? No chance.

Marks and Spencer

I think Marks and Spencer also fails the sustainable competitive advantage hurdle. Granted, there's been a revival at the retailer over the past few months or so. But the fundamental problem with M&S is clothing -- it's a very poor industry for the long-term shareholder.

With fickle customers, changing fashions and low barriers to entry, a sustainable competitive advantage is difficult to maintain in this particular sector. Granted, M&S has plenty of attractive retail space and George Davies appears to have a magic touch. However, there are plenty of other businesses around whose competitive 'moats' are far wider and more durable. Nice food, though.

Misys

Misys fares a little better in the competitive advantage front. They're a leading player in the world of banking IT systems, an industry whose customers don't chop and change suppliers at the drop of a hat. However, while the company does earn steady, stable revenues, the management strategy remains questionable.

As well as distinctly clouding its financial performance, Misys' growth-by-acquisition philosophy implies a lack of management creativity. This feature highlights how Misys has reinvested all of its past profits into acquisitions. It's hardly a sign of the entrepreneurial spirit that drives most businesses to long-term success.

Following the Qualiport's disposal, Misys has since purchased US software firm Sunquest for $404m and domestic IFA network DBS Management for £75m. Old habits die hard. The poor fundamental characteristics of Misys remain intact.

Dell

At the other end of the management spectrum, the accomplished Michael Dell remains firmly in charge of Dell Computer. But the past year has been dreadful for the PC industry. Dell, the industry number one, reported flat sales and a 34% fall in operating income within its latest nine-month numbers.

However, Dell's asset-light, low-cost business model is coming to the fore in these difficult times. Dell has increased its US market share from 20% to 26% over the past year; to grow from 14% to 20% took Dell over two years. Furthermore, recent trading woe at Gateway (NYSE: GTW) and Compaq (NYSE: CPQ) has highlighted Dell's relative strength. But with a price to earnings (P/E) ratio of 44 and plenty of decent UK companies to choose from, there's no prospect of an early Qualiport return for Dell.

Unilever

Purely in terms of its business, Unilever is probably my favourite ex-Qualiport stock. Owning and manufacturing a broad range of branded food and household goods is as good a long-term business as they come.

However, Unilever's financial measures aren't half as attractive as its products. The group is now in the midst of a 'Path to Growth' programme, a strategy culling some 1,000 products at a cost of £3.3b. Operating profits were reduced by 33% during 2000 by the group's 'exceptional' restructuring.

This quick comparison between six different branded consumer goods firms showed Unilever lagging against Qualiport watch list firms Allied Domecq (LSE: ALLD) and Imperial Tobacco (LSE: IMT). With similar growth prospects, but without the costly restructuring, I'd go for either Allied or Imperial over Unilever.

Rentokil Initial

That just leaves Rentokil Initial. In the two years following the Qualiport's disposal, Rentokil has become a much more attractive business. For starters, it has (partly) made amends for the acquisition of BET and sold off many of its less attractive, lower margin businesses. Such humdrum activities as rat catching, tropical plant watering and security services now help to generate juicy operating margins of 18%.

In addition, the group has also embarked on an extensive share buy-back programme. Since March 2000, Rentokil has reduced the number of its shares in issue by a third. Such actions are typically an indication of rational management running a business generating excess cash -- a great investment sign.

Although earnings growth of 10% is forecast for the next year or two, Rentokil's forward P/E of 20 doesn't indicate a stock market bargain. That said, all things considered, Rentokil is probably the pick of the ex-Qualiport bunch. Whether the company can justify an entrance to the watch list is a decision best left for another day.

More: Qualiport Trade History