The search for “reliable defensive” shares leads straight to the door of Associated British Ports, says The Fleet Street Letter. Why? Because right now it is offering “an excellent long-term record in an industry with high barriers to entry” at a pretty undemanding price. Ports are essential pieces of infrastructure that offer a wide variety of difficult - “if not impossible”- to replicate services: not much of the UK coastline is suitable, there is no quick way around planning restrictions and the trend to increased ship sizes that need deep water berths will only reinforce the position of the incumbents. Note that in the last 40 years only two significant new ports have been built: one in the Shetlands, as a result of the North Sea oil, and Felixstowe. The top ten of 1965 are all still in the top 20. “Few, if any other, industries can provide investors with such a degree of stability.” The barriers to entry in the market also mean high operating margins for the ports: ABP, which is the UK’s largest operator, enjoys margins of more than 40%.
Swedish chief executive Bo Lerenius took over in 1999. Since then, he has sold off non-strategic assets, concentrated on winning long-term port contracts with a guaranteed 15% return on investment and grown earnings per share by 24% to 30.9p in 2002. ABP now operates 21 ports, the largest being the Grimsby and Immingham complex, and handles about a quarter of the UK’s seaborne trade. From here, medium-term growth should come from an investment of £600m in a proposed deep water container port in Southampton. Part of this cash will come from increased borrowing, but ABP’s “long-term record is good enough to justify gearing up”. On a “hardly expensive” p/e of 14 times, a “modest” price to book ratio of 1.4 times and offering a yield of 3.5%, the shares are a buy. They “could easily hit 520p within 12 months”.
Rising tide of shares for Watermark
Since June, airline services company Watermark has seen its shares rise 45%, says the Investing for Growth newsletter. And for good reason: over the last year, the company has put in place the building blocks for its future growth with a series of deals that will transform its vision of total supply management ‘above the wing’ into reality. Watermark bought an airline products recycler in April to cater for the 90% of its customers who operate in the EU, where from next year fines will be imposed on airlines that do not recycle ‘in-cabin’ items, such as headsets. It has also picked up a distributor of newspapers and magazines, and committed to seven joint ventures, among them one with Duty Free Air Ship and Supply, the world’s largest provider of onboard retail programmes and Inflight Productions, the largest buyer of TV programmes for airlines.
The upshot is that Watermark can now supply all of the 400 products used by airline passengers during flights - from eye shades and socks to plates, condiments and hygiene products. The growth potential is huge. The world’s suffering airlines are desperate to reduce their operational costs, and outsourcing cabin operations can help them do this. Yet right now the average airline only outsources around 2-3% of the business. The firm is also diversifying into airflight services, and to this end has established a joint venture with Aerobox to sell Aerobox aerofreight containers to its 120 clients. This is a $975bn market and the aerobox product has huge advantages over rivals: it is lightweight, can be flat-loaded, and the composite material from which it is made can be easily repaired. Given this, the containers should steal 10% of the market within the first four years. That will add 1.3p to Watermark’s earnings per share for 2005, 2.9p in 2006, and 6.1p in 2007.
In the first half of 2003, Watermark’s business was adversely hit by the SARS virus and the war in Iraq. Interim results showed pre-tax profits down 8%. But market conditions have improved substantially, the potential for growth is huge, and the firm has a net cash position and a visible order book with contracts locked in for one to three years. Note too that the directors have a £5m stake, giving them quite an “owner’s eye”. On a p/e of 11 and an attractive PEG of 0.4 times, the shares are a buy.
Small and mid caps head for a downturn
While the FTSE 100 has gained a “respectable” 6% this year, the performance of small and medium-sized companies has been “in a different league”, says Robert Cole in The Times. The FTSE 250 mid cap index, comprising firms with market capitalisations between £250m and £2bn, and the FTSE small cap index, 350-odd firms valued below £250m, have advanced by 28% and 38% respectively. But their outperformance has come to a “shuddering halt” over the past two months, with large, medium and small shares all “more or less unchanged” during this period. So is the party over?
Yes. Small and mid caps now look expensive, with a dividend yield of under 3%; the FTSE 100 offers better value with a 3.5% yield. This premium to larger shares would be warranted if the smaller fry boasted superior growth prospects, but the opposite is the case. Data management group Hemscott notes that 50% of FTSE 100 firms are expected to grow earnings per share by more than 10% over the next 12 months, but only 40% of mid caps and 37% of small caps are likely to do the same. Meanwhile, a majority of large caps pay dividends at least twice covered by earnings; this applies to less than half of smaller firms. Another reason to be wary is that smaller companies are more susceptible to rising interest rates - expected later this year - as they tend to borrow more.
Nonetheless, “discerning” investors can still find attractive smaller stocks. The following picks all offer a prospective dividend yield of at least 4% and should increase earnings by 10% in the coming year. They also boast interest payments covered at least four times by earnings and dividends twice covered by profits and cash flow. They are property agent Savills, campsite operator Holidaybreak, paper company James Cropper, tool hire group Brandon Hire, sausage skin producer Devro, and support services play David Services.
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