First Leisure lays gloom on thick

THE INVESTMENT COLUMN

Gaining a reputation for being the best management in the sector can be a mixed blessing when things do not progress as quickly as the market had hoped. Yesterday's full-year figures from First Leisure were pretty impressive in the context of flagging consumer demand, a hot summer and the competitive challenge of the National Lottery, but the shares still closed 19p lower at 349p.

That was the first big setback in a lucrative year for First shareholders, who have seen their holdings appreciate by more than 50 per cent since the beginning of 1995.

Partly it reflected disappointment at pre-tax profits which, at pounds 40.1m for the year to October, were about pounds 1m lower than some brokers had forecast. But mainly it was due to the gloomy tenor of chief executive John Conlan's comments on consumer spending during the rest of 1996.

Although lower than expectations, the profits achieved during the year were still 7 per cent better than a year earlier, a doubly impressive performance in the context of First's ultra-cautious accounting policies with regard to new developments - the more the company expands the bigger the hit to profits.

Against that background, First did extremely well to increase earnings per share by 6 per cent to 16.98p (excluding last year's asset disposal profits), allowing a 10 per cent rise in the full-year payout to 7.72p.

Analysts think Mr Conlan, a well known Jeremiah, is actually laying it on a bit thick with regard to consumers continuing refusal to dip into their pockets. They are anticipating a noticeable rise in consumer confidence in the run-up to the next election. That will flow straight through to First's low-ticket leisure activities.

Whatever the short-term outlook, First Leisure is pursuing an eminently sensible strategy, using its cash-generative core businesses of bowling, theatres and resorts to fund the rapid roll-out of new formulas such as health and fitness centres, bingo halls, discos and themed bars.

The cost of moving into new areas was shown most clearly by the bingo division where, despite a rise in sales by 58 per cent to pounds 15.5m, profits slipped by 14 per cent to pounds 1.9m. Dancing, however, managed to shrug off the effects of expansion, generating a 17 per cent increase in profits to pounds 17.8m from discotheques from a 14 per cent increase in turnover.

The real impact of all the spending last year and this, of course, will not show through to profits until probably 1998, right at the horizon of most investors' short-term plans. That puts the shares, on a prospective price/earnings ratio of 18 (on forecast profits this year of pounds 45m), at a demanding 30 per cent premium to the market. The best of the run is over for the time being but the shares remain a good long-term hold.

Gas problem can be solved

The political manoeuvring over British Gas's notorious "take or pay" supply contracts has intensified in the past week, increasing the worry for thousands of private shareholders who have seen the value of their investments dwindle since last summer.

On Friday it was reported that the gas giant was considering involving banks in a plan to mount an enormous buyout of the contracts, said on one estimate to be worth pounds 40bn over 25 years. This week, the company's difficulties were underlined by a report that the regulator, Clare Spottiswoode of Ofgas, would not take account of the contract problems during the current review of both gas supply and transportation charges.

Much of this looks like posturing between the parties in the negotiations between British Gas and the North Sea oil companies. But the stakes are high.

The scale of the problem was demonstrated last year, when the company said the take or pay deals had resulted in it forking out pounds 520m for gas it did not use during 1995. If Ms Spottiswoode decides to be tough in her current reviews, the effect could be further devastation to British Gas's profits.

One estimate suggests that the company's TransCo pipeline and storage operation alone could see pounds 1bn sliced off revenues and profits over the three years to 1997. Further damage would be inflicted if the regulator decides to cut British Gas's ability to pass through high gas costs to consumers.

It is hard to pin down who is to blame, but the Government must share some of the opprobrium. It wrongfooted nearly everyone by accelerating deregulation of the domestic market, due to begin in April. As well as a statutory duty to ensure the players in the new deregulated market are financially viable, it therefore has a moral duty to British Gas and the many small shareholders enticed into the 1986 privatisation.

Neither the buyout plan nor a suggested levy on consumers looks politically acceptable. But a solution is by no means impossible. The pounds 40bn estimate of the buyout cost is based on a 10p gap between contract and spot gas prices. The difference in British Gas's costs is more like 3p to 4p, which would cut the bill to a much more bridgeable figure nearer pounds 3bn on a discounted basis.

A gloomy tale, but despite profit estimates cut to around pounds 830m for last year, the shares, down 12p at 255.5p, are still worth holding on a p/e of 13. The yield of 7.1 per cent is attractive and the possibility of a takeover cannot be totally ruled out.

Budgens' niche looks vulnerable

Budgens' management must be pleased with the decision to abandon its budget format last year. It was a costly move, which involved selling unwanted stores to Lidl of Germany and converting others into the standard Budgens format. It also wrecked the company's full-year results in July and sparked a spectacular falling out with its big German shareholder.

Half-year results announced yesterday, however, showed that the company is finally starting to put its ill-fated dabble with discounting behind it. Pre-tax profits for the six months to November jumped from pounds 0.9m last year to pounds 4.3m this time.

Like-for-like sales figures have also motored ahead and were up 4.5 per cent on the same period last year.

Significantly, the company has not been buying higher sales by giving away margin. Operating margins have improved due to Budgens' membership of a pounds 3bn buying co-operative which is attracting new members and a decision to devote more space to fresh foods, which yield higher margins.

The company hopes that its new Budgens Visa card, launched yesterday, will help improve loyalty and drive sales. The company insists it will not hit margins, though it declines to say how.

Budgens also insists that it is not caught in no man's land between the Continental discounters and the big superstore groups. Its niche, it says, is as a "top-up shop" which complements the others.

This may be true but it leaves the group vulnerable to attack. A Kwik Save assault on fresh foods would hurt. And Safeway is poaching more and more family shoppers from Budgens' back yard. The problem here is that once a store loses primary shoppers it has to work twice as hard to replace them with secondary customers.

A good set of results, then, but not enough to generate real excitement. With NatWest forecasting full-year profits of pounds 7.5m, upgraded from pounds 5.8m, and with the shares up a penny to 34.5p, compared with net assets of around 31p, on a forward rating of 11 the shares look no more than a hold.