Wilson Connolly still overrated

THE INVESTMENT COLUMN

Six months ago we expressed surprise in this column at the generous treatment of house-builder Wilson Connolly's share price after a disappointing set of interim figures. Since then, despite a continued deterioration in the housing market, the shares have nudged curiously higher, so yesterday's 7 per cent fall from 174p to 162.5p, after even worse full-year numbers, was about time.

Wilson Connolly is proof positive of the lethargy of investors, who will often continue supporting a company long after it has become evident that the investment story has changed. The company is still the well run outfit that impressed shareholders in the 1980s, but the environment in which it operates has changed out of all recognition.

Profits for the year to December at pounds 22.5m represented a dramatic collapse from the pounds 38.2m achieved in 1994. They were also well below already reduced expectations of nearer pounds 26m. Earnings per share tumbled from 13.5p to 8.1p, leaving the maintained 4.54p dividend covered, if less than generously.

As the company freely admits 1995 was a false dawn. The problems persuading house-buyers to part with their cash were also exacerbated by a tightening of the planning process which meant that analysts expectations of 4,200 completions during the year were badly undershot at 3,870.

That had a double effect on profits because in order to boost flagging volumes, Wilson had to slash prices lower than it would otherwise have done. Lower volumes would be expected to reduce the net margin, through poor overhead recovery, but lower prices hit the gross margin as well.

The bad news is that the outlook for price rises remains as bleak as ever. The bottom end of the market that Wilson occupies, with its three and four-bedroom houses selling for an average of less than pounds 60,000, remains wickedly competitive. This is very much a buyer's market.

House prices are cheaper than ever, say the builders, trotting out the usual price to wages ratios and low mortgage cost arguments. Actually, says one broker, they are merely more affordable, an important distinction because cheapness is quickly rectified by an efficient market while affordability can persist for years.

One of the reasons Wilson's share price has remained as resilient as it has over the past year or so is the undoubted financial stability of the company. At the year end the balance sheet sported pounds 33m of net cash.

If the recovery implied by this gloomy backdrop is as gentle as many observers fear, however, then housebuilders should be valued on a very different basis from that currently used by the market. And a p/e of 19 falling to 16, assuming profits of pounds 25m this year and pounds 30m next time, is much too high a rating, with little support from a dividend yield of only 3.5 per cent. The market is still being over generous. Sell.

The flotation of McBride, Europe's biggest maker of own-label detergents, has left a good deal of egg splattered over the new face of SBC Warburg, the blue chip merchant bank which sponsored the issue. Floated at 188p last July, the shares are now languishing at 129p, up 5p yesterday, after a catalogue of woes hit the company last year, forcing it to issue a profits warning in January.

The bounce in the shares, despite a new warning that second half profits would be lower than last year, seemed to reflect relief that first half results were no worse than already much reduced expectations. Pre-tax profits slumped from pounds 14.7m to pounds 8m in the six months to December, hit by the now well publicised problems caused by the hot and humid summer weather, which wreaked havoc in its soap powder plant in Cumbria, and rampaging raw material prices.

McBride has taken action to sort out management in the Barrow and Middleton operations, where last year's difficulties were concentrated, and is set to take another 200 jobs out of the group in the second half, on top of 400 already slated to go over two years at Middleton. The cost of the extra redundancies will depress second half profits, but should bring benefits on top of the pounds 4m annualised returns expected from the shake- up already underway at Middleton.

With raw materials either flat or falling, management is confident the worst is now over and has declared a maiden dividend of 2.25p, in line with the prospectus forecast. But plenty of questions continue to hang over McBride.

It is not entirely clear that everthing that happened last year was due to bad luck. It transpires that the company was already having difficulty meeting demand for conventional powders produced by Barrow in May, well before the realisation dawned in July that the new super-concentrated detergents being made for Sainsbury and Safeway caused clogging in the machines. More seriously, it is now facing a new price war launched by Procter & Gamble, the Fairy Liquid to Ariel giant, which has been suffering market share erosion.

Next year is clearly going to remain competitive. Kleinwort Benson expects profits to recover to pounds 21m this year, rising to pounds 30m next. A 1996-97 multiple of 10 would appear to discount the worst, but this management has a lot to prove. Continue to avoid.