18 - 24 November 1999

Investors' Corner

The Market

The London sock market ended the week on a disappointing note, hit hard by a fall in FTSE 100 heavyweight Vodafone AirTouch. Analysts seemed concerned about Vodafone Airtouch's intentions towards German group Mannesman. The FTSE 100 Index closed down 39.8 points at 6511.6, with Vodafone single-handedly responsible for 31.1 points of the deficit. The weakness however, did not extend to the FTSE 250, which closed 22.3 points higher at 5918.8, and the FTSE Small Cap, which settled 33.9 points stronger at 2786.7. Market turnover was heavy, hitting 1.7 billion by 4.50p.m. on Friday, swollen by 115.7 million Vodafone AirTouch shares changing hands.

Meanwhile, the boards of Celltech Chiroscience and Medeva announced that they had reached agreement on the terms of the proposed merger of the two companies. The merger terms value each Medeva share at 165p and the entire issued share capital of Medeva at approximately £563 million.

British Airways

British Airways, reported a 39 per cent drop in its pre-tax profits to £240 million for the half year to September 30. To counter the severe criticism the group's chief executive claimed that British Airways' plans are based on three fundamental elements. First, cutbacks in capacity and the revised fleet strategy will improve margins and returns over the next 2 years. Second, new products like the Next Generation Club Europe launched in September; Club World Flying Beds effective from 1st March 2000, the upgrading of Concorde from next September and higher levels of customer service will be delivered. Third, cost efficiencies from the final year of the Business Efficiency Programme - boosted by further profit improvement actions in the current year and beyond - will be delivered in excess of original targets. These actions BA claim, in combination, will put the airline in a strong position to compete successfully.

Operating profits have been adversely affected by lower yields; mainly by the glut of low fares in the market derived from excess industry capacity. BA's borrowings, net of cash and short term loans and deposits, amounted to £5,368 million at September 30, 1999 - down £158m since March 31. The reduction was due to cash received on the issue of Euro 300 million Cumulative Preferred Securities in May.

In terms of its aircraft fleet, BA will have the first delivery of the Airbus A318 in January 2003. These A318s will enable more efficient crewing and maintenance and will allow the airline to respond more flexibly to changing market conditions on shorthaul routes. They will also replace its Boeing 757s on domestic and European routes.

Whilst the immediate outlook for British Airways is challenging, the positive actions of the management in changing the fleet and network strategy and the continued focus on customer service and cost efficiency should restore the profitability of the company.

Railtrack

Railtrack, the rail infrastructure provider, announced that it is on course to increase the infrastructure spend in the second half of the financial year to reach a level of £2 billion for the full year - an increase of 16 per cent.

Over 80 per cent of this investment has a safety benefit since safety is a major issue in Britain's rail industry in view of the Paddington Rail disaster and a series of other train mishaps. In fact a National Safety Performance Board has been set up which will be the forum for rapidly driving forward the necessary cross-industry changes, which include the nation-wide implementation of a confidential reporting system, the signals passed at danger ("SPAD") action plans, actions on driver training and all the required work on the Train Protection and Warning Systems. At present an internal industry inquiry, under the independent chairmanship of Richard Bonham-Carter, is seeking to establish the immediate and underlying causes of the recent accident and make recommendations aimed at preventing, and mitigating the consequences of similar accidents in the future with Railtrack being fully committed to assisting the inquiry team.

Railtrack is already reviewing the feasibility of accelerating the introduction of the Train Protection and Warning System, which is considered to offer a real improvement to the present system and can do so more quickly than any alternative Automatic Train Protection system. In parallel, Railtrack is developing for the West Coast Main Line a modern signalling and control system within European standards that will provide full Automatic Train Protection. With the Channel Tunnel Rail Link being the first to be fitted with ATP throughout.

Negotiations are also progressing with Government and London Transport over a public/private partnership agreement for the renewal and maintenance of the sub-surface routes of the London Underground. Railtrack is also exploring the options for linking certain of the sub-surface lines with the national rail network, to create new journey opportunities in and around London.

This year Railtrack faces a particularly tough challenge of improving its passenger delay minutes per train by 12.7 per cent, this was after the Regulator issued a draft enforcement order to that effect. It has also planned better construction efficiency by making better use of the periods when train services are suspended for engineering works and they have set targets for increased utilisation of such engineering possessions. Railtrack is also having trouble with its freight business that is at cross- roads. Other than coal, there is currently little evidence of the hoped-for increase in demand materialising.

Meanwhile, an initial paper from the regulator is expected to be published next month, which will give investors a clearer picture of the company's permitted rate of return and the likely scale of investments.

Unigate

Unigate, the European food and food and distribution group, reported a 38 per cent drop in pre-tax profits to £42.1 million for the six months to September 30. The company's shares dropped to a new 12-month low as the results revealed a punitive 27 per cent slump in underlying earnings before goodwill and exceptionals.

Trading conditions have remained challenging and consequently Unigate's food businesses have, as predicted, had a difficult first half. However, Wincanton has continued its excellent performance.

Unigate's operating profit before exceptional items and goodwill amortisation was £53.4 million, compared with £59.5 million last half year. These results reflected difficult trading conditions particularly in Malton Foods which suffered from severe margin pressure and in St Ivel, where volumes in the UK had been disappointing.

However, much has been done to improve performance. In Malton, factory rationalisation and other significant cost reductions have been implemented. In St Ivel, management changes have been made and the new teams are addressing the actions needed to rebuild St Ivel's margins.

Changes have also been made to its slaughtering capacity which has been reduced with cessation of production at the Brunel Road Spalding facility in September. This was in response to the reduced availability of British pigs and in order to meet retailers' demands for competitive prices.,

Unigate's overall yogurt and desserts volumes fell 16 per cent. However while its own label yogurts and desserts volumes were down, volumes of Shape and Cadbury branded desserts continued to show good growth. Price increases gained for both yogurts and desserts are expected to improve margins in the second half.

Unigate's convenience foods businesses of Terranova acquired in May 1999, contributed £8.7 million on sales of £199 million. Terranova's sales in the UK were up 5 per cent and operating profits up 9 per cent on a comparable basis. Frontline Foods showed a particularly strong improvement despite disruption caused by a fire at its Great Yarmouth factory. Smedley's also reported improved performance, whilst Pinneys and Telfer were affected by lower sales..

Unigate's dairy profits fell by 21.7 per cent to £15.9 million. Profits suffered from the impact of sterling's strength against the Euro on butterfat realisations, which was not sufficiently compensated by lower raw material costs. Overall milk volumes increased 6.6 per cent during the period, reflecting in part the contribution from the doorstep business of Wessex Dairies which acquired at the end of last year. However there was an underlying decline in doorstep sales when compared with that achieved the year before of around 7 per cent. The performance of the Dairy business in the second half will however benefit from a further fall in milk costs from 1 October in response to market conditions, particularly for butterfat realisations.

The results of a recent MMC inquiry into milk procurement in the UK vindicated Unigate's concerns with Milk Marque's selling system. Milk Marque has now announced its intention to split into three regional co-operatives. Wincanton logistics has strengthened its presence in the non-food retail sector, securing new business with Ikea, WH Smith, Woolworths and the Littlewoods/Arcadia home shopping joint venture. In addition it has gained future new business with Nestle/Friskies Petcare and Scottish & Newcastle Retail. All divisions of Wincanton continued to perform well.

The trading environment for food manufacturers remains challenging, particularly in the UK, where Unigate's major customers are embarking on a series of price driven initiatives. Given the management actions taken and the progress made on acquisitions, Unigate expects the company to achieve an improved performance in the second half of the year. It also believes that the combination of these management actions taken and the development of its strategy of building a pan-European food and distribution group place the company in a strong position for the future.

Please note that the value of investments, and income (if any) yielded by them, may fall as well as rise, and you may not recover the full amount of your original investment. Past performance is not necessarily a guide to the future.

James DeBono can be contacted by e-mail: JamesDeBono@CompuServe.com