QUALIPORT
Three Obscure Franchises

By Maynard Paton (TMFMayn)
September 14, 2004

Operating margins are a filter for possible 'franchises'. By making more profit from every £1 of sales, a high margin firm could well have some sort of pricing power over its customers. Such power could stem from limited competition or a strong operational advantage, both of which are attractive features of any long-term share. Read more.

The following three companies have recorded consistently high operating margins in the past. They are however far from being prominent stock market names.

1. Victrex (LSE: VCT)

Victrex describes itself as an 'innovative, world-leading, high performance materials group'. The firm is the sole manufacturer of polyetheretherketone (PEEK), a high performance thermoplastic claimed to possess a 'unique combination' of properties. The properties no doubt give the product (which is used in a variety of markets including aerospace, electronics and food processing) its competitive advantage.

Victrex joined the market in 1995 at 170p per share and at 335p is currently valued around £270m. Progress since the listing has been steady. Sales have risen from £38m to £72m, pre-tax profits have improved from £13m to £23m while the dividend has increased every year, from 4.5p to 7.5p per share.

Note however that Victrex's performance can be volatile. In 2002, the company cited the global economic slowdown for an 18% reduction in turnover and 16% contraction to earnings. But operating margins have been consistently high throughout the quoted period, with anywhere between 27% and 34% being recorded.

2. Pinewood Shepperton (LSE: PWS)

Pinewood Shepperton is Europe's leading provider of studio and film-related services. It owns extensive facilities used for major film productions, studio television recordings, the filming of commercials and post-production sound services. Pinewood's competitive advantages are said to include the number, range and sizes of its studios, a variety of specialised on-site film services and its proximity to Heathrow and central London.

After acquiring a listing earlier this year, Pinewood shares have gained 51p to 231p, which values the group at nearly £110m. Pre-2001 accounts are hard to come by, but between 2001 (when Pinewood Studios bought Shepperton Studios) and 2003, sales advanced £7m to £37m and operating profits put on £5m to £11m. Underlying operating margins over the past three years have been 20%, 29% and 30%.

3. Parkdean Holidays (LSE: PDH)

Parkdean is the country's third largest holiday park owner. Parkdean aims to build its estate -- currently consisting of 15 sites -- by acquiring parks from small independent operators. Parkdean alleges 'few, if any' new parks are currently being constructed in the UK due to 'onerous' planning restrictions. It also claims 'no significant new park developments are anticipated'. The industry is highly fragmented with the biggest player owning only 40 of the UK's 3,500 or so sites.

The shares have done well since their 2002 listing. From an initial 100p price, they now stand at 213p, giving Parkdean a market value of roughly £85m. Since 2000, revenues have surged from £15m to £54m while profits soared from £2m to £9m. Last year, the dividend was doubled. Operating margins have been between 20% and 27% during the past four years.

Pros and cons

The trio have their pros and cons.

Victrex has the most attractive and proven track record. However, it suffers from low investor visibility. It isn't obvious how PEEK can sustain its competitive advantage or who or what its competitors are. The danger for shareholders is relying too much on what management say if things turn sour. Nevertheless, Victrex undoubtedly has reputation for quality and innovation, which should be hard to displace.

Pinewood's an interesting share. Its facilities and location limit competition while also creating decent barriers to entry. Trying to replicate Pinewood's 200-plus acre estate somewhere near the M25 will be very difficult and expensive. Existing industry rivalry however could be Pinewood's problem -- American producers can always make their films in Hollywood. Canada has a number of studios too, which benefit from being on the American continent and having certain taxation incentives. In the UK, there are also studios at Elstree, Ealing and Leavesden, though each possesses fewer facilities than Pinewood.

Like Pinewood, Parkdean also enjoys planning and location barriers to entry. Holiday parks just can't be constructed as and when and it's fair to say the best sites have already been taken. But Parkdean's major shortcoming is substitution. There are a myriad of alternative holidaying options available, including seaside B&Bs, Butlin's, Center Parcs (LSE: CPK), luxury hotels and overseas trips. That said, running a caravan park would seem simple and boring enough to warm the hearts of most buy and hold investors.

So, will any make the Qualiport's watch list? Sadly none come near to the likes of Associated British Ports (LSE: ABP), Imperial Tobacco (LSE: IMT), Johnston Press (LSE: JPR) and the London Stock Exchange (LSE: LSE), all of which have competitive advantages that are more obvious, more proven and more sustainable. That said, the three could have a place in a more diversified long-term portfolio. If the Qualiport was forced to look at them further, the order of preference would be Pinewood, Victrex, Parkdean.

Maynard owns shares in Associated British Ports, Halma, Johnston Press and London Stock Exchange.

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