Survivors of the business Ice Age

RECESSIONS for companies are rather like ice ages for the world of nature. The weak go out of business or become extinct; the strong remain to dominate the industry or their part of the planet. Huge profits can be made from identifying such companies and buying them early in the recovery phase when they can enjoy startling profits growth and make cheap acquisitions of struggling rivals.

Two examples are environmental consultancy RPS, at 115p, and steel erector Severfield-Reeve, at 207p. The latter's shares have doubled since I recommended them at 100p last September but I confidently expect them to double again.

RPS, too, has just reported a 71 per cent increase in profits to pounds 2.23m and 32 per cent increase in earnings per share to 9.5p for 1995. This is a far cry from 1991 when the group reported a pounds 500,000 loss and the shares plunged to a low of 23p to capitalise the business at just pounds 2.8m against pounds 22m now. The latest profits are a record for the group and the earnings equal the earlier high point achieved in 1990. The share price, though, is little more than half its peak leaving large scope for further recovery. On stockbrokers' forecasts of 1996 profits reaching pounds 2.8m to pounds 3m and earnings, held back by a rising tax charge, reaching 10p the prospective p/e is still an undemanding 11.5.

But those forecasts could be left well behind if, as I expect, the company keeps making acquisitions. RPS employs 350 people, mostly fee-earning, in 17 branches throughout the UK and Ireland. Its chairman, Alan Hearne, claims that RPS is the biggest player in a fragmented industry and has the opportunity to become "a major force". Many smaller rivals are struggling and eager to sell. Last year the group paid pounds 2m, financed by a share placing at 79p, to buy two companies with annualised turnover of over pounds 4m, which contributed pounds 370,000 to profits in the six months since acquisition. Helped by RPS's financial strength and operating systems, these acquisitions could be contributing pounds 2m to profits in a year or two. It is also evident that more deals are likely.

Much of RPS's opportunity comes from growing pressure on companies both to operate in an environmentally sound manner and also not to take on potentially disastrous environment-related liabilities. Its clients already include Nuclear Electric, the property firm MEPC, TI, ICI and Ministry of Defence. Work on the proposed Heathrow Terminal 5 alone brings in pounds 700,000 plus a fee income.

As the environmental agencies come on stream with huge budgets, the pressure on companies to be environmentally responsible is going to add to the group's workload. A combination of steady sales growth and incremental margin improvement means earnings could advance by at least 15 per cent a year even without acquisitions. These prospects are not recognised in a rating at a discount to the overall stock market.

Severfield-Reeve is also using acquisitions to give what could be a powerful fillip to an already fast growth rate. It has just announced the acquisition, for pounds 800,000 in cash, of Rowen, a substantial southern-based steel erection business. The modest price belies an important deal for the group. Last year Rowen produced 20,000 tonnes of structural steel against 35,000 for Severfield-Reeve and had a turnover of pounds 31m against pounds 39m.

The big difference is on the profits front: pounds 493,000 for Rowen against its new parent's just reported pounds 2.2m. If Rowen's profitability can be improved, the potential is obvious. Stockbroker ABN Amro Hoare Govett is forecasting profits for the enlarged business of pounds 4m for 1996 and pounds 5.8m for 1997, to drop the p/e to around 10.

Apart from rapidly expanding its structural steel business, Severfield- Reeve also has a potentially exciting diversification called Manabo. This is a new business, 25 per cent owned by its founder, Richard Hawley, which has acquired the UK and world rights, excluding parts of Europe and Scandinavia, to a range of cleaning machines for use in the meat and poultry industry. Investors have reacted with a certain amount of caution to the group's plans but John Severfield and John Reeve are sufficiently impressed to be spending pounds 2.3m on a new factory for Manabo's products.

The various expansionary moves are being financed by a placing to raise pounds 6.6m with a clawback facility for shareholders on the basis of one share at 180p for every four shares held. If Manabo lives up to expectations, there is an opportunity for the group to multiply its market capitalisation severalfold before the end of the decade. Prospects look very attractive.