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Investment Column: Debt down at Punch, but it is still too risky

ARM Holdings; Croda International

Alistair Dawber
Thursday 30 April 2009 00:00 BST
Comments

Our view: Sell

Share price: 117.75p (+32.75p)

If you are a high-risk, high-return investor, the pub operator Punch Taverns might be just the one for you.

The group trades on such a lowly multiple that taking a speculative punt might be worthwhile, even for those on the look-out for safer stocks. Of course, there is no such thing as a free lunch and while the stock is worth peanuts, some analysts argue that buyers run the risk of holding not very much.

The problem is debt. Lots of debt. Punch issued solid first-half results yesterday, adding that it has managed to pay down £318m so far this year, including making £91m of disposals. On the face of it, the company is doing all the right things, but some worry that Punch is not able to pay off the debt quickly enough. Watchers at Evolution point out that the £318m represents just 7 per cent of the total debt of £4.5bn: a huge amount for a company with a market capitalisation of just £226m before yesterday's share price increase. The analysts say sell, arguing that there are too many higher-quality names in the sector to choose from.

Sadly, we would have to agree. Yes, the stock trades at a laughably low level, but the market reckons there is a fine line between success and failure. "Our 40p share price [target] is based on 9.1 times Ebitda [underlying earnings] to August 2009. On a multiple of 8.9 times Ebitda, the share price would be zero," say the Evolution watchers.

Its chief executive, Giles Thorley, says that as with most of the pub companies, Punch has suffered during the recession. He argues the group has stabilised and that long-term shareholders are aware that the next two years will be a time to batten down the hatches and pay off debt. More assets will be sold off, he says, and the debt is being paid off quicker than expected.

If Punch manages to plot a course through the next two years, punters who buy will do well. We worry that the risks are too great, however. Sell.

ARM Holdings

Our view: Buy

Share price: 116p (unchanged)

It is clear from speaking to ARM Holdings' finance director, Tim Score, that the group considers the current problems in the semiconductor industry an annoyance, rather than anything more serious.

The microchip designer put out its first-quarter numbers yesterday, saying that revenues were down 10 per cent. This, says Mr Score, is as a result of the wider market falling 30 per cent in the same period and that ARM's results are solid. The shares over the same period, up nearly 25 per cent, would certainly reflect this view.

Ordinarily, we would be a bit nervous about investing in any falling market, even if the company in question is doing less badly than its peers. We are tempted to make an exception in ARM's case, however.

Mr Score says that the group is concentrating its efforts on longer-term possibilities in products such as smartphones. The group's technology is used in 100 per cent of these products at the moment, he says.

The future certainly looks rosier than the present for investors. Some analysts say the stock is reaching fair value – those at its house broker UBS ascribe a price target of just 130p – but we are prepared to back ARM as a longer-term bet. Buy.

Croda International

Our view: Hold

Share price: 527p (-31.5p)

Mike Humphrey, chief executive of the speciality chemicals company Croda, has had a sinking feeling recently. Thankfully for shareholders, it is down to him being an avid supporter of the struggling Hull City, rather than anything to do with the group's share price.

Indeed, the stock has been a decent performer, up nearly 10 per cent in the last quarter before yesterday's first-quarter trading statement. And perhaps the shares would have performed even better had it not been for the group's industrial chemicals arm, which has struggled as customers opt to destock existing supplies.

Croda's consumer care business, on the other hand, which supplies the likes of L'Oreal, is racing ahead with record quarterly profits and revenues.

As the recession continues, investors will have to rely on continued growth from the consumer side of the company, and for a number of analysts the recent rise in the stock already puts it at a fair level.

Those at Killik argue that "the shares are currently trading on 10.5 times consensus 2009 earnings and, following a period of strong performance over the last few months, are probably due a pause for breath in the short term".

We believe Croda is a solid bet, and that an investment should remain safe. There are better opportunities for growth in the market, however. Hold.

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