The Investment Column : De La Rue facing a credibility gap

De La Rue has had things too easy for too long. The group's sharp rise in profits in the early 1990s was brought to a shuddering halt last year and two trading warnings have brought the shares to their level of four years ago. Many of the problems lie in the recent upsurge in new capacity attracted into the lucrative commercially-supplied banknote market, which De La Rue dominates.

De La Rue can hardly be blamed for that. But it also enjoyed a one-off and unrepeatable boost from the break-up of the Russian monopoly on banknote production in the former Soviet empire. It produced the paper money for the newly independent states and helped them to build their own state- owned printing plants.

The chickens have come home to roost over the 30 months as banknote margins have tumbled, but De La Rue was calling the turn yesterday. Reporting pre-tax profits down 13 per cent for the six months to September to pounds 60.3m, chief executive Jeremy Marshall said there were signs that pricing was stabilising. Indeed, prices are showing a rise of around 4 per cent in the latest six months, giving the group the confidence to raise the interim dividend by 3.4 per cent to 7.5p.

There was also encouraging news from Portals, the security paper company acquired last year for a net pounds 540m after disposals. That business raised its profits a third to around pounds 13.5m in the period. Meanwhile, Garny, the German safes to cash handling business, appears to be recovering from the competition which hit it last year, with profits up from pounds 700,000 to pounds 1.6m in the six months, and US orders are returning despite the continuing disruption from bank mergers.

But De La Rue still has something of a credibility gap to overcome. Far from increasing barriers to entry and so widening margins, adding gizmos to banknotes like optically variable ink, which changes colour depending on the angle of view, has actually squeezed returns as the prices charged have not covered the increased cost. Margins in the security paper and print division, De La Rue's most profitable, have accordingly slumped from close to 26 per cent to just over 21 per cent.

In the long run, the group still has plenty going for it. Holograms on banknotes and "smart" chips on payment cards, another market it dominates, should provide differentiation and a spur to growth.

The extra pounds 4.7m spent in the half year on development of new products in cash handling should also deliver long-term benefits, even if it hit returns in the latest period. But profits are likely to fall again to pounds 135m this year, putting the shares, up 3.5p to 558.5p, on a forward multiple of 13. Hold for the long term.

Vodafone keeps

rivals at bay

Judging by Vodafone's half-yearly results yesterday, confidence is tentatively returning to the mobile phone market, turned on its head early this year when Vodafone and Cellnet, threatened by the upstart Orange, launched a massive price war. The result was a period of damaging turbulence, as all four networks signed up customers who wanted the kudos of owning a mobile phone but apparently didn't want to make any calls on it. Average spend per customer was on its way down from around pounds 600 in 1994 to somewhere approaching pounds 400 depending on the operator.

At first glance Vodafone's figures, despite a 21 per cent rise in pre- tax profits to pounds 252m, show all the scars of battle. Its customer base grew by just 203,000 in the half-year to the end of September, down from 371,000 the previous year. Cash earned from each subscriber also fell from pounds 481 to pounds 430, while it is having to pay more to service providers, the retailers who sell mobile phone airtime, to persuade customers to sign up.

Yet Vodafone has come off better than its three rivals, most particularly by pulling out a huge lead over Orange in the digital market. As Sir Gerald Whent, the group's retiring chief executive smugly pointed out, in January Vodafone had just 17,000 more digital subscribers than Orange, whereas now the lead has stretched to 300,000. Orange would no doubt argue that its customers are fast becoming more loyal and spend more, but the fact remains that Vodafone has strengthened its role as market leader, backed up by much greater marketing muscle. Seen in this light its pounds 77m takeover of Peoples Phone, which admittedly made losses of pounds 7.3m last year, seems a sensible defensive move. The second source of strength which singles out Vodafone is its international expansion, which turned in a profit, excluding exceptional costs, for the first time.

Vodafone forecasts the UK market will grow next year at 20-25 per cent, about the same rate as 1996. The business is likely to remain as competitive as ever, however, and prospective earnings growth in the low to mid-teens makes the shares, up 11.5p to 254p, look pricey on a prospective price- earnings ratio of 23 falling to 20.

Unigate delivers under pressures

No one can accuse Ross Buckland of inaction during his tenure as Unigate's chief executive. Non-core businesses such as the US restaurants have been sold along with the stake in Nutricia, the baby foods business, last year. Unigate is now focused on food and the Wincanton distribution division. Investors are waiting for the next move.

The sale of the Nutricia stake for pounds 300m was a year ago now and very little of the cash has been spent. Unigate had pounds 56m of cash at the end of the half- year, a figure that will rise to the best part of pounds 130m at the year-end.

Management is clearly looking for a deal. A US deal has more or less been ruled out as Unigate would be a small player in a large market. A continental European operation to strengthen Wincanton is the likely option.

Though the company admits it has funds for a "sizeable acquisition" Mr Buckland is unlikely to hurry a deal as the performance in the core business is steady. Pre-tax profits were flat at pounds 60m due to lower prices of butter and milk powder products as well as the absence of the Nutricia contribution.

The fresh foods division, which includes the St Ivel and Malton pig meat businesses, performed strongly with profits 29 per cent higher. However, the dairy business continues to be affected by lower doorstep deliveries. These were 11 per cent down on the previous year though the rate of decline is slowing. A further problem was the loss of a supermarket customer which caused supermarket sales to fall by 2.4 per cent. Wincanton continues to win new distribution contracts, with Argos, Lever Brothers and Mars among the latest recruits.

Assuming full-year profits of pounds 126m, Unigate shares - up 2p at 432p yesterday - trade on a forward rating of 11. There are competitive pressures such as Unilever attempting to build its margarine market share, but the shares look good value.