Dalgety dogged by Pedigree problems and BSE crisis

The Investment Column

It is two years since Dalgety launched a pounds 186m rights issue to pay for the near-pounds 500m deal to buy Quakers' European pet food operations. The cash call was priced at 335p. Yesterday the shares were barely above that level, closing up 1.5p at 341p. It has clearly been a rough two years for chief executive Richard Clothier and the jury is still out on whether the business is turning the corner.

At the time of the Quaker deal, the strategy to sell consumer foods divisions such as Golden Wonder and Homepride to concentrate on pet food looked plausible. But a lot has gone wrong since then.

The BSE crisis has hit the group's animal feesuds division, the rival Mars-owned Pedigree Petfoods has been aggressive on pricing and the strength of sterling has affected overseas earnings. Integrating the Quaker pet foods business cost far more than originally anticipated.

The wounds were apparent in yesterday's half-year figures with pre-exceptional profits in the six months to 31 December down pounds 4m to pounds 43m. It was the agribusiness division which suffered most, with the BSE-inspired export ban causing excess capacity and increased costs, which were compounded by the strength of sterling

Though pet food profits held up, the dog food business has been dented by Pedigree's marketing muscle. Dalgety's Felix brand has held off a marketing challenge by Pedigree's Whiskas brand. In dog food it will be hoping that its Winalot re-launch with the slogan "Live a lot, wag a lot, Winalot," raises sales as well as smiles.

With Dalgety's shares a long way south of their mid-1995 high of 480p, the group faces serious questions. The first is whether it can build its pet food business to do battle against Pedigree. Margins used to be measured in double digits in this business but are a long way short of that now.

Another question mark hangs over whether the group really needs four divisions. The US distribution business, which is dedicated to McDonald's, seems non-core though Dalgety is unlikely to raise more than book value for it. This business has not been helped by the slowdown in like-for- like sales at McDonald's outlets.

With the dividend barely covered by earnings, the City will start to become restless is there is not a Dalgety revival in the second half and management could find its position under scrutiny.

The animal feeds business should begin to stabilise post BSE, while the food ingredients division is solid enough.

With analysts forecasting full-year profits of pounds 104m falling to pounds 116m, the shares trade on a forward rating of 15 falling to 13. The real attraction is the 8 per cent yield, which should cover the downside risk and makes the shares worth holding.

USAir lifts BA profits

Where will British Airways be in another 10 years' time? Will it still be an airline in the accepted sense of the word or will the craze for shedding staff, cutting costs and outsourcing every conceivable function have turned it into the world's first truly virtual airline? Will it, for that matter, still be called British Airways or will a series of mega mergers have transformed it into a behemoth of the skies, as American or Oriental as it is British?

Those searching for clues in the airline's third-quarter results may be a little disappointed. Despite BA's goal of shaving pounds 1bn from its cost base through the much-vaunted Business Efficiency Programme, employee costs are up by 10 per cent this year. Meanwhile, progress towards gaining regulatory approval for the American Airlines alliance is proving painfully slow.

Had it not been for pounds 11m in dividend arrears from USAir, its erstwhile transatlantic partner, BA would have been celebrating a decade of private ownership not with another set of record figures but with a small decline in third-quarter profits.

True, many of the efficiencies pushed through by BA's chief executive Bob Ayling, such as packing the accounts department off to Bombay, are yet to show through. Nor can any amount of inspired leadership stop aviation fuel prices rising by a third - the drag factor that is doing most to hold BA back.

Volatile oil prices, are, however, a fact of life for airlines. In the short run, BA will be judged on how well it has hedged its oil exposure and how quickly it can plug the gap in revenues that will be left when the USAir code-share agreement expires in April.

In the longer term, the challenge is to make the American alliance work in an era of open skies and increased competition while preventing the BA brand name from being devalued by too enthusiastic an approach to cost cutting.

Assuming full-year profits of pounds 640m this year and pounds 710m in 1998 the shares, up 11p at 597.5p, stand on a forward multiple of 12, falling to 11. They should still have some way to go, but given the uncertainties BA faces, a repeat of the 500 per cent return shareholders have enjoyed in the first decade of private ownership looks implausible.

Still questions over Admiral

Sir Lawrie Barratt, the chairman of Britain's second-biggest housebuilder, was quick to criticise rival Bryant for overpaying last year when it bought Admiral Homes for pounds 62m. The deal gave Bryant a ready-made land bank in the South-east of England, where the recovery in the housing market has been strongest and development land is in shortest supply due to delays in planning permission.

But analysts remain perplexed as to why Bryant paid pounds 6m more than Admiral's net asset value to buy, in effect, a job lot of plots. Normally purchasers would expect a discount, especially as Admiral was in the red at the time.

The result is that at 25 per cent, Bryant's plot cost to selling price ratio continues to be a burden. House price inflation was only modest in the six months to November and the group's average selling price, including Admiral, fell by pounds 3,000 to pounds 113,000, hit by a change in mix as more three- bed and fewer four-bed properties were sold.

But a rise in operating margins to 8.6 per cent from 6 per cent helped push pre-tax profits 52 per cent higher to pounds 15.5m on sales of pounds 257m (pounds 232m). The maintained dividend of 1.45p was covered by earnings of 3.7p (2.4p).

Bryant sees a progressive improvement in confidence among home buyers rippling out from the South-east. It cites as evidence a 30 per cent rise in net reservations continuing into the second half - even if the corresponding year's figures were lousy - and it looks on course to hit its target of building 4,000 homes this year.

Better still, there are no signs yet that the prospect of a general election by May and the possibility of a rise in interest rates is affecting purchasers' confidence. With a fair wind and a post-election "honeymoon", double- digit margins are a distinct possibility next year as Bryant recovers from a low base.

But concerns about the Admiral deal and the continued presence of the small construction division will surely limit its recovery potential.

UBS has raised its pre-tax profits forecast for the year to May by pounds 2m to pounds 37m. That puts the shares, up 0.5p to 150p, on a chunky forward multiple of 17, yielding 4.2 per cent. High enough.