QUALIPORT
Cheap Shares For A Long-Term Portfolio

By Maynard Paton (TMFMayn)
July 11, 2002

Over the past two months, the FTSE 100 has fallen 17%. The rapid decline has left many shares on the Qualiport's watch list attractively priced.

I'd strongly urge any collector of quality businesses to evaluate the following shares (more details can be found by clicking on the company name):

Allied Domecq (LSE: ALLD) at 399p
Carpetright (LSE: CPR) at 582.5p
DFS Furniture (LSE: DFS) at 382.5p
Lloyds TSB (LSE: LLOY) at 606p
Metal Bulletin (LSE: MTLB) at 144p
PizzaExpress (LSE: PIZ) at 406p
Renishaw (LSE: RSW) at 370p
SSL International (LSE: SSL) at 290p
Ultraframe (LSE: UTF) at 266p

All are very near to -- or at -- valuations I'd say were attractive for a long-term investor.

So what now?

Four of the Qualiport's six shares are on the above list. But with just £99.98 in the bank, the portfolio will have to sell to take advantage of Mr Market's depressive mood. So what now?

Here's a quick run down on the immediate investment pros and cons of the Qualiport Six:

Carpetright (LSE: CPR)
Share price: 582.5p
Portfolio value: £3,931.88

Pros: Recent results were impressive. Shares are cheap, offering a historic free cash flow yield of 7.4% and historic dividend yield of 5.7%.

Cons: Property market downturn would hit profits.

DFS Furniture (LSE: DFS)
Share price: 382.5p
Portfolio value: £902.70

Pros: Shares are cheap, offering a historic free cash flow yield of 7.6% and historic dividend yield of 5.6%.

Cons: Property market downturn would hit profits. Given buoyant housing market, latest results weren't spectacular.

Emap (LSE: EMA)
Share price: 762p
Portfolio value: £2,834.64

Pros: Underlying annual performance held up well in a difficult advertising market. Boardroom's cautious optimism could signify worst is over.  

Cons: Experienced Chief Executive to step down next year. With a prospective free cash flow yield of 6.3%, the shares are not the cheapest around.

Johnston Press (LSE: JPR)
Share price: 350.5p
Portfolio value: £5,636.04

Pros: Purchase of Regional Independent Media was a good move, with 2001 sales and profits advancing despite poor industry conditions. Recent trading was ahead of expectations.

Cons: Valued on a free cash flow yield of 6.2%, the shares are no giveaway.

Lloyds TSB (LSE: LLOY)
Share price: 606p
Portfolio value: £3,090.60

Pros: Solid blue chip with a prospective dividend yield of 6.0%. Forthcoming interim results will show 'a satisfactory performance'.

Cons: Worries over asset 'resilience' of investment business and bad debt surprises. Complex accounts are no help.

PizzaExpress (LSE: PIZ)
Share price: 406p   
Portfolio value: £2,614.64

Pros: Shares are the cheapest in the portfolio, exhibiting a free cash flow yield of up to 10%.

Cons: Recent sales warning could signal fundamental trouble. Earlier departure of Chief Executive adds to the concern.

Time to switch?

There are plenty of cheap shares around. Is it time for the Qualiport to make a change?

The points to consider are:

1. The portfolio's best and worst businesses;
2. Current portfolio weightings;
3. Other non-portfolio share possibilities;
4. The differences in valuation, and;
5. The costs of switching (e.g. commission at £15 a trade).

Following a lot of thought on the financial characteristics, operating predictability and competitive advantages of each Qualiport member -- and ignoring valuation -- here's how I'd place the portfolio in order of 'business' attraction:

    Company             Current portfolio percentage

1. Johnston Press                   29%
2. Emap                             15%
3. Lloyds TSB                       16%
4. Carpetright                      21%
5. DFS Furniture                     5%
6. PizzaExpress                     14%

Essentially, I asked myself:

"If I had to go away for ten years, which company's progress would I be most confident about on my return?"

It was very close, but the greater reliance on management talent didn't favour the retailers. The franchise nature of the portfolio's two media companies was an important factor. To capitalise on the market gloom then (i.e. top-up either Carpetright, DFS, Lloyds TSB or PizzaExpress), the Qualiport will have to reduce its exposure to its two most inherently attractive businesses. Not an ideal scenario.

Furthermore, it's not as if Johnston Press and Emap are on toppy ratings anyway. In my mind, there's only a marginal benefit to be gained by switching from companies on free cash flow yields of over 6% (e.g. Emap) to one that's yielding over 7% (e.g. DFS).

Of course, PizzaExpress is the cheapest share in the portfolio, with an estimated free cash flow yield of 10%. Unfortunately, it also has the most operational concerns within the portfolio. Switch from steady-ish Emap into PizzaExpress again? Tough call.

Another factor to consider are the possibilities outside of the portfolio. At the moment, there are two other companies on the Qualiport's watch list that are in appealing valuation territory -- Ultraframe and SSL International. In addition, Allied Domecq, Metal Bulletin and Renishaw have also fallen close to enticing share price levels.

Of those five shares, I'd say Metal Bulletin, Renishaw and Ultraframe -- in that order -- are my favourites. However, of these three, only Ultraframe are obviously undervalued at the moment, on a free cash flow yield of 8%.

Conclusion

After considerable time spent contemplating the possible changes, I've decided...

... to do nothing.

The six businesses in the portfolio are all quality companies that should reward shareholders over time. Is Ultraframe a better long-term bet than Emap? Difficult to say. Will an investment in PizzaExpress generate a greater return than Johnston Press? Hard to judge.

To me at least, the difference in business qualities, valuations and portfolio weightings don't readily indicate a great switching opportunity.

That said, a change could occur if:

* The shares of Johnston Press and Emap rise, and/or;
* The shares of Lloyds TSB, Carpetright, DFS, PizzaExpress or Ultraframe decline further.

or..

* Another, more inherently attractive, watch list company homes into view. I'd place London Stock Exchange (LSE: LSE), Imperial Tobacco (LSE: IMT) and Gallaher (LSE: GLH) in my watch list top four.

Indecision

All this apparent indecision stems from one fact: the Qualiport is currently 99.5% invested. Unlike most ordinary investors, the Qualiport does not have the benefit of regular cash injections.

But make no mistake. If the portfolio had a suitable cash balance, it would be buying.

The author owns shares in Carpetright, DFS Furniture, Johnston Press and PizzaExpress.