(*underlying)

The results were solid. Turnover at ABP's ports improved 6% to £182m while the division's underlying operating profit increased 4% to £70m. ABP's core operating margin is thus a very attractive 38%. Non-port property activities added a further £3m to profits during the half-year. Net debt increased £8m to £445m and the dividend was lifted 4% to 7p per share.

Something worth noting is that ABP's capital expenditure will be heavy in the years to come. More than £400m is to be invested in the group's ports over the next ten years, with a £45m riverside terminal for coal imports and a £28m roll-on/roll-off facility (both at Immingham) currently under development. Importantly, ABP continues to confirm it monitors maintenance capital expenditure with a view to keeping it under the depreciation charge.

ABP's results also served up a few investing lessons:

1. Dibden write-off: The half-year contained a £45m exceptional write-off relating to the aborted development of a terminal at Dibden, near Southampton.

To recap, rather than expense the Dibden costs against earnings when they were encountered, ABP had capitalised them as 'assets in the course of construction' and 'land held for development' in the balance sheet. But when the Dibden plan was rejected by the government earlier this year, ABP had no option but to make the exceptional charge and in hindsight had effectively flattered profits of previous years.

Though the treatment of the Dibden costs has raised a few eyebrows, current accounting standards do allow companies to capitalise development costs when:

a) There is a clearly defined project, and;
b) Related expenditure is separately identifiable, and;
c) The project has a reasonable completion prospect, at which point revenues are expected to exceed costs, and;
d) Adequate resources exist to complete the project.

In ABP's case, the term 'reasonable completion prospect' left plenty of scope for misjudgement.

Lesson: Shareholders disappointed by write-offs should always inspect accounts carefully. ABP revealed the Dibden costs within its bookkeeping small print and investors did have the opportunity to make profit/valuation adjustments prior to the government's decision. Note also that cash flow was not affected by the decision to capitalise costs; the cash was spent as and when the costs were incurred.

2. FRS 17: ABP has adopted FRS 17 for 2004. However, the new practice for pension accounting has had a notable effect on profits -- past and present.

The introduction of FRS 17 caused 2003 pre-tax profits to be restated from £146m to £134m and 2003 earnings per share to be restated from 31.0p to 28.6p respectively. These represent declines of 8% or so and are despite ABP reporting a £26m net pension scheme surplus at the end of December 2003!

A precise figure wasn't given, but the six months to June 2004 probably experienced a £7m reduction due to the FRS17 adoption. (ABP still carries a £26m pension scheme surplus.)

Lesson: Even if a company has a pension scheme surplus, future profits may still be held back by the new reporting standard.

3. Property interests and valuation: ABP's property operations present a bit of a valuation dilemma. They contribute a worthwhile amount to earnings, but the division's profits are lumpy and will dwindle lower as the group continues to sell off further non-port sites.

In the past, the Qualiport has lumped together the ports and property profits together to produce a free cash flow calculation. On this basis, assuming profits remain flat, the twelve months to June 2005 should witness pre-tax profits of £164m and free cash flow of £93m, or 29.2p per share. Demanding a 7.5% free cash flow yield would therefore require an entry price of 389p.

However, a sum-of-the-parts valuation is more appropriate in this situation. In terms of ABP's port-related activities, pre-tax profits came to £154m in the year to June 2004. If profits remain flat, free cash of £86m, or 27.1p per share, could be generated during the next twelve months. A 7.5% free cash flow yield would give the port operation a value of 361p per share.

On the property side, ABP also has about £79m, or 25p per share, worth of 'other investment properties' and 'property developments and land held for sale' declared on its books. Add that to the port valuation and the buy price comes to 386p.

Although these two buy prices are very close, they could diverge in future if the property and land is re-valued higher or more likely, following the disposal programme, ABP is one day left with valuable sites but which do not produce that much of an income.

Lesson: Earnings may not always give the whole valuation picture with firms that have differing income streams or that are asset-rich.

More: Britain's Quality Port | Quay Features

Maynard owns shares in Associated British Ports.

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