Guinness's price policy makes sense

The Investment Column

Guinness has been bad for its shareholders for years now, but the past six weeks have provided a healthy tonic. Following an upbeat trading statement in January, borne out by yesterday's full-year figures, the Johnnie Walker to stout group's shares have risen almost 20 per cent to yesterday's close of 501.5p from a year's low of 426p. The hangover from the consumer party of the 1980s may not be over, but the head is at last clearing.

The pounds 1bn profit mark remained elusive in 1996, but only, Guinness claimed, because of the extra interest it had to pay to fund last March's share buy-back. That left pre-tax returns at pounds 975m, but naturally gave a fillip to earnings per share, which at 34.8p were 19 per cent up on last year's provision-hit figure and 6 per cent better on a comparable basis. The dividend rise of 8 per cent to 16.1p means the stock has outstripped the rest of the market on that measure over the past five years, if on few others.

The company is plainly on the mend, benefiting from the decision a year or so ago to end the folly of price promotions in its spirits arm in favour of the tried and tested, if expensive, technique of building its enviable portfolio of brands. The first evidence of improvement started to show through in the US last year, where for the first time in ages all Guinness's so-called power brands - Johnnie Walker, Dewar's, Tanqueray and Gordon's - increased volumes. Prices moved ahead too, although the progress is pretty glacial.

Getting the rest of the industry to follow suit on pricing has not been easy and in the competitive home market spirits' profits slipped 9 per cent as the decision to hold the line on prices hit volumes.

It is clearly the right approach, however, and the benefit will start to flow this year. In the rest of the world, volumes moved ahead nicely and developing markets now account for 44 per cent of divisional profits, up from 30 per cent five years ago.

Brewing is doing well as Guinness finally gets to grips with exploiting its stout's unassailable brand around the world. Again, the cost of achieving an 8 per cent rise in draught Guinness volumes was sizeable in marketing terms but last year's advertising sets a nice platform for growth. If beer was the group's dominant product, not mature spirits, it would be set even fairer than it is.

As it is, however, the unresolved problems at Cruzcampo in Spain (where profits of pounds 22m on investment of pounds 900m remain pathetic) and the likely pounds 60m hit from the soaring pound mean Guinness will struggle to do better this year than last. That puts the shares, up 15.5p yesterday in the face of a tumbling market, on a prospective price/earnings ratio of 15. That is hard to justify on the basis of profits growth, which is likely to remain pretty pedestrian, but continuing strong cashflow will ensure that buy-backs will progressively reduce the equity base. Fair value.

Rugby still struggling

The painful process of managing decline continues at building products group Rugby. In joinery, a net 350 jobs will go as a result of the recent acquisition of Boulton & Paul for an initial pounds 15.5m, with factories closing this week at Burton-on-Trent and Maldon, Essex.

The Boulton & Paul deal made Rugby the biggest supplier of doors in the UK but buying dominant market share and cost leadership means little in a low-inflation environment where demand is, at best, patchy.

Last year a 2 per cent drop in joinery turnover knocked 35 per cent off pre-exceptional operating profits to pounds 9.1m while a 2.5 per cent fall in cement volumes dented profits there by 12 per cent to pounds 16.6m.

In US manufacturing and distribution, which accounts for 40 per cent of sales, profits nudged ahead to pounds 11.9m from pounds 10.2m. Action is also being taken here to cut costs, especially in building products where profits fell.

Australia suffered from what Rugby claims is the sharpest housing downturn since the early 1970s, though it cannot be talking about Sydney, which has become a boom town ahead of the Olympics.

All this meant that across the group pre-tax profits before one-off items dropped by 14 per cent to pounds 62.5m on flat sales of pounds 1.14bn. Pre-exceptional earnings per share fell from 8.3p to 6.6p though the dividend was held at 2.1p.

Rather belatedly, Rugby is getting round to the idea of translating profits at average rates - as most of its peers have been doing for years. Currency movements lopped pounds 3m off the bottom line last year.

Rugby says price rises in the UK of up to 10 per cent since the year- end appear to be sticking but having proclaimed so many false dawns before, it is right to be cautious.

So should investors. Plans to invest pounds 120m in a new cement factory at Rugby will increase net capacity by almost 20 per cent when it comes on-stream towards the end of 1999. That looks like throwing good money after bad.

And the outlook in the US is just as bad, with the number of housing starts falling and interest rates poised to go up.

Profits of pounds 68m rising to pounds 89m in 1998 put the shares, down 2p at 114p, on a prospective p/e ratio of 16 falling to 12. The discount to the sector is deserved. Unattractive.

Kwik-Fit looks a lot fitter

Kwik-Fit, the fast-fit car parts group founded and run by the irrepressible Tom Farmer, has done well since its annus horribilis five years ago, when profits collapsed, and the high operational gearing which hit the group then should increasingly work in reverse this year.

Certainly the 19 per cent jump in pre-tax profits to pounds 43.3m for the year to February looked creditable against a 17 per cent rise in turnover. However, that increase looked less impressive when account is taken of the pounds 8.2m gain recorded on the sale and lease-back of 40 Kwik-Fit depots, even if it was offset in part by the pounds 5.1m write-off of the development costs of the fledgling insurance broking operation. In fact, the underlying profits growth in the existing business was 5 per cent and overall operating margins were flat at just over 10 per cent.

Mr Farmer, who saw his own pay rise from pounds 942,000 to pounds 1.12m last year, blamed the margin restraint on a regular five-yearly upgrade of fitters' salaries, which helped boost staff costs by a fifth last year. The absence of that one-off this year should allow a bigger proportion of sales to filter through to the bottom line. And despite the maturity of many of its markets, Kwik-Fit's pursuit of market share has already seen 1996 sales increases ranging from 9 per cent in exhausts to 26 per cent in tyres as it launched into the fleet market.

The group has 50 greenfield sites in the pipeline to add to its current total of 866 fast-fit outlets stretching from Ireland, across the UK to Holland and Belgium. That should take it well on the way to the target of 750 in the UK.

But the real excitement lies in insurance broking, which has broken into the black after just 18 months, turning a pounds 900,000 first-half loss into pounds 2m profits in the second six months. The ground is not as fertile as when Direct Line started, but there is clearly plenty of scope to capitalise on the Kwik-Fit brand.

Underlying profits raised 15 per cent to pounds 46m this year would put the shares, up 0.5p at 241p, on a forward multiple of 13. Attractive.