Bottom Line: Graham plays a cautious game

YESTERDAY'S pricing of Graham, the builder's merchant being spun off from BTR, was more conservative than expected, raising just pounds 210m at 183p a share, compared with forecasts of up to pounds 250m.

Partly that reflects a misunderstanding by analysts of the group's average debt burden, which at between pounds 30m and pounds 35m is rather higher than they thought.

As a result pre-tax profits, forecast to rise from pounds 13.5m to about pounds 17m this year, are a fraction lower than previously thought, reflecting a higher interest charge.

But the pricing also indicates a laudable realism about Graham's position within a highly fragmented and competitive industry.

By its own admission, the company has work to do on its margins. It has a worse product mix and less efficient distribution than, for example, Travis Perkins. As a result its operating return on sales is unlikely to be higher than 5 per cent this year compared with Travis's 6.5 per cent margin.

The company stresses the scope for improvement which, together with rising volumes, should give profits a substantial lift over the next few years. If Graham gets it right, its currently unimpressive margins can actually be seen as a plus for the shares.

But BTR is right to think that shareholders will demand a discount to compensate for having to wait and see if Graham's management is up to the challenge.

Selling more high-margin kitchens and bathrooms and encouraging more customers to pick up their own goods rather than having them expensively delivered may be the correct strategy, but its implementation will take time and has its own risks.

On a prospective price/earnings ratio of 18.5, compared with 22 for both Travis Perkins and Wolseley, the discount investors are being tempted with is a reasonable one of about 16 per cent. The case for the shares is strengthened by a prospective yield of 3.5 per cent, a small premium to Graham's peers. Worth applying for, but don't expect a first-day premium of more than about 10 per cent.