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VALUE INVESTING
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A well known company and a FTSE 100 member too, though in fact it is the smallest constituent in terms of market capitalisation and is thus in danger of being ejected from the index at the next quarterly reselection. History indicates, though, that being ejected is not necessarily harmful to the share price of companies facing that prospect. Railtrack (LSE: RTK), as the name suggests, maintains the railway tracks and the general rail infrastructure. It does not actually run the trains. Here are the fundamentals: Note that there is a very wide spread of forecasts for the 01 and 02 year ends, indicating a major uncertainty about the profitability of the group. To illustrate this, earnings per share forecasts range for 2001 from about 37p to 70p. For 2002 the range is from 57p to 174p! I often use the lowest in this sort of analysis for conservative reasons but it is unusual to see such a massive range in the predictions. Around 12 brokers made these estimates. The accounts for 2001 will show a loss. The company itself has already predicted this in an announcement made in January 2001, but the analysts' forecasts represent their normalised version of earnings per share -- that is, stripping out exceptional items of which 2001 has had more than its fair share, from the Hatfield crash with its resulting national track maintenance programme, to flooding. I recall writing a message on the value board after the Hatfield incident last year, commenting that it was unusual that the price of Railtrack had not been hit by this. I was looking for a possible crisis play here: a version of the value strategy that bets on the chance of making some money out of a misfortune that may have had a disproportionate and temporary adverse effect on the shares. But despite the enormous amount of bad publicity following Hatfield the shares were not hit. Not then, anyway. The real collapse occurred this year, 2001, in which the shares have fallen some 55% from their high point as finally all the bad news came home and the company announced in January that it would make a loss for the year to end on 31 March. It appears that the amount of money required to rectify all the track problems would have been enough to almost destroy the company, and the rail regulator stated in March this year that Railtrack must implement its recovery plans for the network by 21 May 2001. None of which, of course, was likely to have a positive effect on the share price. In consequence, the Strategic Rail Authority announced in April that the Government is willing to provide £1.5b in funding for the company. The price remains on the floor, only marginally above its five year low. Prior to the current crop of disasters, it had in fact shown quite nice growth, with eps rising from about 41p in 1996 to 85p in 1999. Dividends rose accordingly from 13.8p to 26.3p over that period. The forecast P/E for 2002 of 8 on the lowest forecast is not much for such a large company, even with its recent history. On the highest forecast it is incredibly low, no more than about 3 with a yield of some 6%. Railtrack is cheap, perhaps deservedly so given the sort of problems to which it is prone. That is one way to look at it. Yet before Hatfield it was on a P/E in the mid-teens. If in future Hatfield and the other problems like flooding turn out to have been a coincidental concentration of generally highly unlikely disasters, then the fall may have been overdone -- seriously so, giving scope for a handsome recovery. In any event it appears that all the bad news may now be in the price. That does not mean it cannot fall further, of course. But it does mean that the downside appears now to be limited by low P/E, high yield and low Price/Tangible Book Value, and yet the upside appears quite substantial -- the ideal balance of risk and reward sought by value players. In addition it is a large cap, which is a further safety feature. It smells quite good to me, although the debt rules it out as the kind of share into which I might sink my wad. Clearly there are risks, as with all shares. More disasters could befall the company but at this price it is very defensive. As with most value plays, a lot of patience may be required for the recovery but if the forecasts turn out to be reasonably accurate then I see some quite serious upside sooner or later.