Scrutineer: Brought Down to Earth

By Martin Flanagan

John Menzies

229.25p -40.7p

A COMPANY like John Menzies, with a big aviation services division, was never going to escape the ravages of the oil price on the airline industry.

There was bound to be an inevitable knock-on negative domino effect. Edinburgh-based Menzies’ aviation domino duly fell over yesterday.

A profits warning from the group related to its battered passenger and cargo handling business wiped GBP 24 million or 15 per cent off its stock market value.

With the current economic gloom, that situation does not look as if it will improve for Menzies in the short term. As such, shares in the company may stay flat for a while, at best.

The profits warning had analysts scurrying to downgrade their profit estimates.

Iain Macarthur at Arbuthnot was pretty typical.

He has cut his profits forecast for Menzies’ aviation services division by not far off a third to GBP 14m from GBP 20.6m this year.

He also does not think things will improve in 2009, but at best stabilise, pencilling in GBP 14m profits for that division for that year as well.

The group’s problem is that its airline customers are being squeezed on two fronts: falling cargoes as business orders decline and fewer passengers amid the credit crunch.

That means the airlines cut scheduled services. And that means there is less work for Menzies’ ground operations.

Particularly worrying for the City in assessing the likely earnings performance of the company is that cargo volumes in particular are difficult to predict.

Whereas scheduled services give an idea of the passenger volumes Menzies may have to deal with, cargo volumes are intricately tied up to the health of the economy.

And in the current volatility those forecasts could vary almost from fortnight to fortnight.

About 40 per cent of Menzies’ aviation business is in that problematic cargo-handling area.

Some studies have also been done that suggest over several decades there has been a relation between GDP and air cargo volumes.

Some have said air cargoes outstrip GDP in good years by up to 2 per cent – and undershoot GDP by up to 2 per cent in bad years.

If the US and UK are on the brink of, or already in, practical recession, then the implications for Menzies do not look good.

Fortunately, and ironically, Menzies’ wholesale newspaper distribution arm is providing some stable ballast for the company as things get stormy elsewhere.

Wholesaling has not been a star turn for the group in recent years as the sexier margins in aviation services have dominated City interest.

But the difference is that wholesaling is not as notoriously cyclical a business as aviation, the latter being joined at the hip with the wider economy.

Now those “stable” earnings at the wholesaling arm are coming into their own and giving Menzies a bit of cash flow breathing space.

And the prognosis? Menzies will be hoping in the short term that distribution continues to partly offset the battered aviation arm, and gives it at least partial perceived “defensiveness’” in the economic gloom as far as investors are concerned.

Then, medium to long term, the company will hope aviation will ride any economic upswing and give some lustre to earnings again.

As such, the stock looks primarily for those not after any big capital gains in the short term (defined probably as about the next 18 months at least).

I think the basic two-pronged strategy at Menzies remains pretty sound. It is reminiscent of the old Ladbrokes’ twin model of “exciting” (Hilton) hotels earnings and “solid citizen” bookmaking earnings.

That hotels business made hay when the economic sun shone; but it was more than once rescued by the steady bookmaking arm when things got tough.

They were eventually demerged, which does not seem a likely option for Menzies at present.

A flotation in the current climate of anything connected with the bombed-out, budget-slashing airline industry would hardly be a roaring success.

So the likelihood is the two-pronged business model will be retained – with, ironically, the papers Menzies is delivering in bulk for a decent profit being full of the reasons why its other division has sparked a profits warning.

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