US Edition Brixton
43½p -19p
Questor says Back takeover
Shares in Brixton tumbled 30pc yesterday as shareholders in the industrial property company reacted with shock at the value of Segro's all-share agreement to buy the company.
The deal prices Brixton, which owns warehouses around Heathrow airport, at £107m, a discount of almost 40pc compared to its previous market capitalisation of £170m at the market's close on Friday.
The announcement is the latest in a string of setbacks for investors who have seen the shares fall from a peak of 587p in 2007 to just 14¼p in March.
Brixton's annual results three months ago read like a horror story – pre-tax losses of £768.8m, vacancy rates above 20.3pc and a warning of "material uncertainty" from auditors. The company has been at the forefront of the turmoil in commercial property.
Brixton's problem is that, unlike its rivals, including Segro, it has been unable to launch a defensive rights issue, a failure which contributed to long-standing chief executive Tim Wheelers' departure. This meant that a fall in asset values of 10pc from the end of 2008 would cause it to breach covenants on June 30.
Brixton has since sold more than £80m of property, agreed a one-month covenant waiver, and is in talks on refinancing its £862m debt pile.
But the situation is still grim and Questor believes it is important to remember this when considering Segro's 1.75-for-one share offer.
Shareholders, who are likely to be asked to vote on the proposals when Segro has completed due diligence, need to ask what the alternatives are and how strong an enlarged Segro could be.
One alternative is the collapse of Brixton, although more likely is its banks effectively taking control of the group given their willingness to support ailing customers.
There are other interested buyers – believed to be private equity – but details are scarce and clearly Brixton's board believe Segro's offer has merits.
Brixton shareholders would own less than 20pc of the enlarged business, but it would be one of the biggest industrial property companies in Europe with assets of around £5.5bn.
However, given Segro's own financial problems – it launched a £500m cash-call earlier this year and plans
another £250m equity raising to support the acquisition – bondholders fear a fire-sale of Brixton's best assets and cumbersome banking terms for the enlarged group.
They are concerned that Segro would eventually hit new financial problems and are ready to table alternative proposals.
Questor understands this opinion, but until concrete alternatives emerge he believes shareholders should back the Segro deal for fear of damaging consequences if no deal is struck.
Reckitt Benckiser
£27.71 -2p
Questor says BUY
Questor recommended buying shares in Reckitt Benckiser at the start of March when they were at £24.96 because their dividend looked safe. The shares are now 11pc above that level – and remain a buy. The shares do not have a spectacular dividend yield, which now stands at 3.2pc, but Questor believes this is safe. The company still looks undervalued by historical standards. About 75pc of the group's sales come from products that are number one or two in their category, such as dishwashing product finish, surface cleaner Cillit Bang and acne treatment Clearasil.
Last week, Morgan Stanley increased its forecasts for the group and argued that the shares were trading at their lowest point since the merger of Reckitt & Coleman and Benckiser in December 1999. With news flow likely to remain positive in coming quarters, the broker reiterated its overweight stance.
Reckitt operates in a relatively defensive sector, it has a strong balance sheet and it is a proactively managed company. It is also extremely cash generative.
There have been concerns about looming generic competition for its suboxone treatment for opiate dependence in the US. There have been fears that this could result in an immediate 80pc fall in sales, but Morgan Stanley says its recent discussions with industry experts had failed to identify an imminent product, suggesting there could yet be further growth prospects for the treatment. However, it really is a question of when and not if generic competition will enter the market. The company also has a good business model. It focuses on developing "powerbrands" through innovation and marketing capabilities, building scale and margins in emerging regions, strict cost management, and volume-driven operating leverage.
The company also has a strong balance sheet. At the end of the first quarter, net debt stood at £693m, £403m lower than the December 31 level. This debt was reduced as a result of strong free cash flow generation – another reason Questor likes this business.
In the first quarter of the year, the group's fully-diluted earnings per share rose 49pc to 42.1p on revenues that were 27pc ahead at £1.9bn. At constant exchange rates, sales were up 8pc.
The company reiterated its target of net revenue growth of 4pc this year and net income growth of 8pc-10pc. Both of these targets are at constant exchange rates. The shares are trading on a December 2009 earnings multiple of 15.7 times, falling to 13.1 in 2010. Questor rates the shares
as a buy.