QUALIPORT
Repeatedly Good Investments

By Maynard Paton (TMFMayn)
October 31, 2002

Predictability of earnings is all-important for the long-term share investor. If you can't be reasonably confident of a company's future profitability, disappointment will surely loom.

When assessing a company's predictability, identifying a sustainable competitive advantage must be top of the list. A wide operational moat is what's needed to keep rivals at bay and those profits rolling in year after year. However, there is the 'repeat purchase' issue to consider, too.

Companies that manufacture products that need to be bought time after time, or provide services that are required on a regular basis, offer far more predictability than a business that produces items of a one-off nature.

A quick check of Warren Buffett's common stock portfolio underpins this assumption. Every day, people drink fizzy drinks (Coca-Cola (NYSE: KO), shave (Gillette (NYSE: G)), read a newspaper (Washington Post (NYSE: WPO)) and use a credit card (American Express (NYSE: AMX)).

Contrast these businesses to say, a double-glazing firm. People don't order double-glazing every day (or even every ten years), so the door-stepping salesman has to find a whole new set of customers each year, every year, just to maintain his employer's profits. Furthermore, assuming most new build properties have double-glazing already, the salesman's market is also steadily diminishing. Needless to say, long-term earnings predictability at your typical double-glazing business isn't great.

So how do the Qualiport watch list companies fare up on the repeat purchase issue?

1) No problem

Lloyds TSB (LSE: LLOY)
Imperial Tobacco (LSE: IMT)
Gallaher (LSE: GLH)
London Stock Exchange (LSE: LSE)
Associated British Ports (LSE: ABP)
Emap (LSE: EMA)
Johnston Press (LSE: JPR)
Metal Bulletin (LSE: MTLB)
Ulster Television (LSE: UTV)
Scottish Radio (LSE: SRH)

Banking presents no problem. Income is generated regularly from long-term saving premiums, current account balances, mortgage repayments and so on. Tobacco, with its addictive qualities, is another great repeat purchase industry. Share trading on the London Stock Exchange is, sad to say, a regular activity for many people. Annual listing fees and price data subscriptions also add to the LSE's predictability. Seaports too have regular custom, the import and export of non-durable goods inherently being an ongoing activity.

The watch list's five media shares also make the 'no problem' list. Continuing profits are generated by daily/weekly/monthly/annual cover price payments, while most businesses have to keep their products in the limelight through constant media advertising.

Sure, people can switch banks, stop smoking and reduce their share trading. But generally speaking, the above companies and their industries have a strong repeat purchase/service nature.

2) Average

PizzaExpress (LSE: PIZ)
Games Workshop (LSE: GAW)

As a recent profit warning suggested, few people dine out at PizzaExpress every night. More likely, visits to a restaurant are made on an ad-hoc basis, with individual diners ranging from the one-off out-of-towner to a once-a-fortnight-at-best local.

Games Workshop is a tricky one. A 10-year-old could be an avid buyer of the company's games, books and model soldiers, but by the time he or she reaches 16, their custom has typically waned. Generally, there's a limited lifespan of solid repeat purchasing, which makes the company 'average'.

3) Suspect

Carpetright (LSE: CPR)
DFS Furniture (LSE: DFS)
Renishaw (LSE: RSW)

Buying carpet and furniture are hardly day-to-day activities. More likely, you'll only pop into a Carpetight or DFS when you move or refurbish your house, which is probably every 5 to 10 years or so. The stores may attract loyal customers, but just a handful of purchases per lifetime means big-ticket retailers have to constantly lure new consumers into their premises.

Selling measuring probes probably doesn't generate that much annual repeat business for Renishaw either. However, considering the company's R&D expenditure, combined with customers wishing to maintain their own competitive position, it's fair to assume replacement sales are made every five to ten years or so.

4) Problematic

Ultraframe (LSE: UTF)

Of the 16 names on the watch list, Ultraframe and its conservatory roofing present the greatest problem. While you may replace carpet and furniture every so often, how many times can you order another conservatory? Ultraframe's business is a bit like the earlier double-glazing example. Although helped by newly built homes, the potential market for new conservatories must surely diminish over time. (This thread has more).

Conclusion

Just four watch list shares -- Carpetright, DFS, Renishaw and Ultraframe -- present some sort of dilemma on the repeat purchase front. However, while individual purchases may be few and far between, the markets for carpet, furniture and measuring probes are generally stable over time (albeit all three are at the mercy of the general economy). Armed with their leading sector positions, Carpetright, DFS and Renishaw should be able to command regular profits from their somewhat irregular customer base.

Operating with almost no replacement business, Ultraframe comes dead last in this particular review. Is the company's robust competitive advantage and wonderful accounts enough to make up for the repeat custom weakness? Should the Qualiport, like Buffett, just focus on those 'franchises' with regular custom? Difficult to say.

More: Discover More About The Watch List Shares

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