BAT is swimming against the tide

The Investment Column

In any other circumstances, BAT Industries' tobacco to insurance operations would be dream businesses to be in. The group combines strong cash flow with growing markets. Even tobacco, a declining market in America and Europe, can still notch up double-digit growth rates in developing areas of the world like the Far East.

The problem is the tide in the West has begun to turn in favour of the anti-smoking lobby, culminating in the revelation that negotiations in the US could lead to the industry paying $300bn over 25 years in settlement of personal injury claims and medical bills. The companies are also facing the prospect that their main product could soon be regulated as an addictive drug by the USFood and Drug Administration.

With problems like that, it is little wonder the group's figures command less attention from the stock market than they used to. Yesterday's announcement of a marginal pounds 1m increase in first-quarter pre-tax profits to pounds 591m caused few surprises among analysts. The shares dipped 3p to 521p.

Lord Cairns, chairman, reiterated last week's warning that the 1997 results would be depressed by the strong pound, which shaved pounds 23m from the quarterly figures on translation alone. Analysts suggested the full- year effect could be as much as pounds 120m with unquantifiable effects on export sales.

Such things are occupational hazards for BAT and there were plenty of signs yesterday that the underlying business remains as strong as ever. Tobacco profits up from pounds 355m to pounds 363m would have shown a decent 8 per cent rise but for a pounds 22m hit taken for the future closure of a factory in Berlin.

The only fly in the ointment was signs that competition has hotted up in the US, with Philip Morris increasing the size and duration of discounts offered to retailers. BAT's US operation, Brown & Williamson, saw its market share slip, but most of the decline was due to the loss of brands it was forced to sell by regulators in the wake of the takeover of American Tobacco.

Financial services, principally encompassing the Farmers insurance group in the US, Eagle Star and Allied Dunbar, were unexciting. The key to BAT remains a settlement of the interminable US litigation, which is now set to spread to the UK. Tobacco share prices soared when the $300bn figure first surfaced last month, indicating the prize waiting to be grasped. Although $300bn is clearly a big sum, it is only equivalent to around 60 cents on a typical packet of US cigarettes.

Barclays de Zoete Wedd believes that BAT without the legal threat could be worth at least 700p more on today's price. Recent events have edged the group closer to unlocking that value, while the current price is underpinned by a lowly forward multiple of 10, assuming profits of pounds 2.67bn this year. Investors should hold the shares but not their breath.

David Brown motors ahead

All three divisions at David Brown Group, the gears to axles engineering group, meshed last year. The synchronicity produced a 19 per cent advance in pre-tax profits to pounds 18.2m, before another pounds 1m of reorganisation costs taken to cover businesses acquired during the period.

The inclusion of the David Brown family businesses acquired the previous year helped the industrial gears division increase sales by 18 per cent and profits by 23 per cent, which now represent 35 per cent of the total.

By contrast, it was mainly thanks to efficiency improvements that the industrial gearboxes and axles operation saw profits advance 13 per cent, despite a more sluggish 5 per cent growth in sales.

The division, which accounts for close to half the group's profits, should see further growth in the current year on the back of new orders and acquisitions.

Meanwhile, the pumps division, which supplies the world-wide oil industry, is benefiting from the continuing trend in developing economies towards local refining of imported crude. Profits rose 23 per cent, but pumps remains the smallest division, accounting for just 14 per cent of profits.

The group counteracted the surge in sterling against continental currencies in the second half of the year by increased efficiency and increased sourcing outside the UK, Chris Cook, the chairman, said yesterday.

The UK accounts for about 60 per cent of output, but less than half the overseas sales are now met by exports from the UK.

European markets were static last year and are not likely to show much improvement in the current year, but they account for only 20 per cent of sales. About a quarter of all the business last year was booked in the Asia Pacific region and Africa, which grew by 25 per cent. The only real cloud on the horizon is the potential loss of the Adco tractor axles contract in 1998, and the immediate outlook is bright.

The shares, up 10.5p to 200.5p, stand on just 10-times prospective earnings if profits hit pounds 19.5m this year. As manufacturing investments go, the share look reasonable value.

Grampian proves

doubters wrong

Grampian Holdings has not been too popular with some of its investors of late. There had been hopes that the sprawling Scottish mini-conglomerate, with interests spread across sheep vaccines, woolly jumper retailing, whisky warehousing and landfill tips, might start to introduce a bit more focus. But instead of selling its minority stake in Edinburgh Woollen Mills, the knitwear chain, as expected, the company conducted a spectacular U-turn last September and bought the remaining shares in the retail group for pounds 69m. This upset some institutions but, judging by yesterday's results, it may be that the Grampian management were right.

Though the figures were confused by a change of year-end and the Edinburgh Woollen Mills deal, profits for the 13 months to January were 31 per cent higher at pounds 13.7m than the calendar year 1995.

EWM was one of the better performers in the group, contributing pounds 5.6m to group profits, including the period when it was still an associate. Stripping out new openings, sales rose by an impressive 12 per cent and the company is planning an aggressive opening programme of 20 stores a year for the next five years. The new stores will be mainly in the south of England, in county and market towns.

While this beefing up of the division goes on, the City is still hoping for disposals to revitalise the shares, which have been treading water for some time. The Patrick sportswear subsidiary was sold last year for pounds 3m and other disposals in the branded leisure division are expected.

Given the market for branded sports clothing, Grampian would be selling into a buoyant market. Yet the shares, 3p higher at 129.5p yesterday, are still a long way off the 180p level reached in 1994.

On current year forecasts of pounds 23m they trade on a forward rating of just 9. Good value.