Asset swap paves the way for better times at Tarmac

The Investment Column

There were few surprises in Tarmac's full-year figures, which had been pretty comprehensively flagged in a trading statement earlier in the year. The movement in the shares, up 8.5p to 119p, underscored the market's relief, however, that the asset swap with Wimpey appears to have paved the way for better fortunes in the second half of the 1990s than the first.

The numbers look a disaster at first blush, with pre-tax profits collapsing from 1994's pounds 107.2m to just pounds 20.3m, a dismal return on sales of almost pounds 2.5bn. But what is important in investment terms is that the market was already aware of a pounds 47m one-off loss on the sale of Tarmac's bricks business and had a pretty good idea that the company was planning to write off the whole of the pounds 30m value of a power station contract dispute.

The underlying pounds 10m fall in profits, moreover, came from the housing operations which are now Joe Dwyer's problem at Wimpey.

Profits there fell from pounds 61.1m to pounds 38.3m as building costs and selling expenses soared, pushing the trading margin down from 11.9 per cent to 7.3 per cent.

There was no price inflation and the number of houses built remained static, so higher costs wreaked havoc with margins. While construction remains a complete disaster, in keeping with the rest of the British contracting industry, the core quarrying and building materials businesses appear to have pulled themselves together after the collective price-cutting madness of two or three years ago.

Profits from aggregates jumped from pounds 45.5m to pounds 63m, a 38 per cent rise, despite a negligible increase in turnover. Although volumes of dry and coated stone, sand and gravel, and readymixed concrete continued falling, prices rose by between 8 and 16 per cent last year.

Encouragingly, the company is confident of pushing through more rises to recoup some of the 30 per cent real decline since prices last peaked in the 1980s boom.

Tarmac is not out of the woods yet, as was evidenced by the sharp fall in return on sales from the new professional services arm and contracting, which managed only pounds 8.2m of profits from its turnover of almost pounds 1bn. There are signs, Neville Simms, chief executive says, of an upturn - strong order books and positive margins in the regional building business - but builders have been prematurely optimistic many times before in the last five years. That said, the market warmed yesterday to the increasing evidence of cost-cutting potential from the Wimpey housing for aggregates asset swap. Taking out the loose cannon of quarry products pricing that Wimpey had become also augurs well for margins. Getting out of cash-hungry housing was plainly the right thing to do and the company's commitment to the private finance initiative will undoubtedly pay off eventually. Against that backdrop, a forward price/earnings multiple of 10.7, on the basis of 1997's forecast profits of pounds 145m, looks reasonably good value against a sector average of 11.3. A 5.8 per cent yield underpins the shares.