Time to take some profits at Somerfield

Somerfield; IMI; Winchester Entertainment

The supermarket shopper has no shortage of recovery plays from which to pick. Safeway and J Sainsbury have both made great strides under their high-profile new management. Yesterday, bringing up the rear, Somerfield said it had stopped losing money, and sales are growing again.

The executive chairman John von Spreckelsen, formerly of Budgens, has instigated a five-year programme of store refits and shaken up the supply chain, building (for sale and leaseback) two new depots in the north of England.

Although the group showed a pre-tax loss of £6.6m for the year to April, that was down from £14.6m last time and masked an operating profit in the second half. Importantly, the group has paid off its debts and has the balance sheet muscle to speed up its investment drive, promising to pilot new store designs at its Kwik Save and Somerfield chains.

But for all the enthusiasm yesterday, when the shares leapt 8.75p to 136.5p, the hard part – establishing sustainable growth – is still to come. In the last two months, sales at the flailing Kwik Save chain are up 3.8 per cent on the same period a year ago, but then they were falling at 15 per cent. Like-for-like sales growth of 6.2 per cent at Somerfield is also against a weak comparison.

For all the sound and fury of recent price-cutting campaign launches, competition among the big grocers is mild, thanks to buoyant consumer spending. Inflation in fresh food prices has been stronger than expected, partly because of a drought in Spain. These are temporary phenomena, and it remains to be seen what the Somerfield figures will look like if there is a consumer downturn, a wet summer, or a pre-Christmas price war.

Even if the benign climate continues, as a consensus profit forecast for the current year of between £20m and £23m suggests, tougher year-on-year comparables and resurgent rivals mean that it is unlikely Somerfield will muster the earnings growth needed to sustain its rating.

The shares have more than doubled in value since their nadir a year ago and those with profits should sell.

IMI

Who would want to be an engineering company with big exposure to the US and Germany right now? That is IMI's unhappy predicament and, sure enough, it delivered a profits warning yesterday.

The jittery markets had already priced in a worse trading environment and so, despite widespread earnings downgrades, the shares ended up.

This was partly because the producer of pipes, valves and other devices for controlling fluids provided some certainty, with the news that first half profits are expected to be down 10 per cent.

There was also relief that IMI moved to address the concerns over a £25m provision that was in its 2000 accounts. The company had not stated what the provision related to and rumours gathered pace that this was only the tip of the iceberg and that its pipes were bursting all over the place.

IMI reacted yesterday, saying £25m was the total cost of the problem, which related to faulty windows, not hard-to-access pipes buried underground. The company is suing its raw material suppliers to try to recover some of that sum.

Back in 1998 IMI was riding high with the shares hitting 532p but it has never recovered from the de-rating of the sector at that time. Martin Lamb took over as chief executive in January this year and has said he wants to reshape the group, focusing on its better-performing businesses and closing a number of manufacturing sites.

But this will take some time, and so will economic recovery in its key markets. Old Mutual, the broker, yesterday lowered its 2001 profits forecast from £140m to £125m, or 23.5p a share. That leaves the stock, up tuppence yesterday to 236p, trading on a sector average 10 times forward earnings. There may be an earnings rebound in prospect in the medium term, but there is no buy case now.

Winchester Entertainment

Film finance may be esoteric compared with the glamour of Hollywood, but it is a lucrative trade nevertheless. That much is apparent from results from Winchester Entertainment.

Years of effort to get deals flowing from LA by Gary Smith, Winchester's chief executive, is paying off. For the year to March, Winchester doubled pre-tax profit to £3.2m, while sales soared fourfold to £20.9m. There is a maiden 1p dividend.

Yesterday Winchester also unveiled a pact that will see it develop and act as exclusive sales and distribution agents to two Hollywood players: Richard Donner, who directed Superman and Lethal Weapon, and Lauren Donner, producer of You've Got Mail. For an optional payment of up to £700,000 per year to develop scripts plus a contribution to overheads, Winchester gets executive producer fees and global distribution rights for all the Donners' films. The incremental revenue over three years from this deal alone could be £15m.

For investors who supported the 315p placing and open offer in November, Winchester, up 6.5p to 186.5p, has been a disappointment. But with one-third of the company's market value of £51m sitting as balance sheet cash, the risk premium in Winchester has dissipated. Buy.