Blue Chip: Granada can still turn it on

Rival company directors peering at their unloved share prices this weekend must wonder what sort of Faustian deal Granada has done to get so much affection in the last six months. In that time Granada's share price has risen by 32 per cent, the company has talked up the success of its Forte acquisition, and its chairman, Gerry Robinson, has assumed the role of chief visionary and guru of British business, the exalted position once occupied by Sir John Harvey-Jones.

While all this initially cheered investors, they have recently become nervous over the company's high debt levels and the lack of obvious logic in combining hotels, restaurants and television. Only two months ago, the shares were looking to break the 900p barrier, but have since slid back to 838p.

For now, investor caution looks justified. Granada's short-term value hinges on its ability to sell off Forte's Exclusive hotel group, which includes Grosvenor House and Hyde Park Hotel in London, for the right price. In the long run, it depends more on how the company fares in the television market, particularly after digital television broadcasting begins next year, and how its newly acquired Little Chef roadside restaurants and Post House hotels respond to cost-cutting and aggressive marketing. While the latter is easier to predict, the fluidity of the television business means anything is possible, and anything less than Granada's full attention in this area could be damaging.

Until recently, the share price reflected the City's feeling that the Granada executive team of chairman Gerry Robinson and chief executive Charles Allen were a good bet to come out of any hotel sale negotiation on the winning side. Analysts even took comfort from the company's announcement at its interim results conference in June that it will delay the sale of the Exclusive Hotel chain until late in the year.

But investor jitters quickly emerged. First was the worry over whether the hotel industry, which emerged robustly from its lingering recessionary hangover last year, will continue to improve its occupancy rates and margins over the next six months. Granada said last month that occupancy rates at Forte's London hotels rose to 84 per cent in the first half of this year, a level not seen since before the recession. In addition, the company claimed there was little loss of business as a result of pushing up rates in its nationwide Travelodge and Forte Post House chains.

But if the profits cycle in British top-class hotels peaks towards the end of the year, the asking price for the Exclusive group, currently pitched at around pounds 850m, may have to fall. Much of the chain's value is locked up in the 595-room Grosvenor House in Park Lane, and any buyer of this property will have to take on some of the less attractive Exclusives (in particular, the underperforming Parisian hotels) to complete the deal.

The second concern surrounds the company's interest bill. The upside here is that Granada's television and electronics rental business and its Sutcliffe Catering operation between them generate enough cash to cover the estimated pounds 193m interest charge for 1996 on a total debt of pounds 3.5bn.

The downside is that a delayed sale of the Exclusive chain would not help the interest position, and might expose the company if the Bank of England succeeds in raising interest rates in the next few months. It would also be harder for the company to raise the pounds 550m or so it needs to fund a bid for the 75 per cent of Yorkshire Tyne Tees Television it does not already own after the Broadcasting Act - which will allow ITV companies to hold more than two licences - becomes law at the end of September.

The worst-case scenario is worth considering but it would be wrong to place too much faith in it. The signs are that Mr Robinson and Mr Allen can do advantageous deals, and are not so overawed by their strategic advisers that they will execute a rushed sale of the hotels into a maturing market followed quickly by a bid for Yorkshire Tyne Tees. They would like a clear run at YTT, and any bid while the hotels (and the pounds 3bn-plus of debt) remains on Granada's books will make investors nervous.

But while the short-term picture remains cloudy, the longer term looks brighter. Even with its debt, the company is in an enviable position. It has a dominant position in roadside restaurants and accommodation, two reliable cash generators in the Granada rentals business and Sutcliffe Catering, and a hotel portfolio that has plenty of scope to improve its margins.

Granada also has one of the youngest chairman-chief executive combinations in the FT-SE 100 index. Mr Robinson is 47, Mr Allen is 38. Both have been appointed to their current posts in the last year; neither will be thinking of leaving in a hurry.

The recent slide in the share price indicates that short-term investors, who bought on the strength of the good vibes put out by the company after the Forte takeover, should take this opportunity to sell. Those who place more value in the longer view should hold on.

Granada

Share price 838p

Prospective p/e 20*

Gross dividend yield 2%

Year to 31 Dec 1994 1995 1996* 1997*

Turnover pounds 2.1bn pounds 2.38bn pounds 3.84bn pounds 4.32bn Pre-tax profits pounds 265m pounds 351m pounds 454m pounds 670m

Earnings per share 32p 39.1p 39.3p 52.7p Dividend per share 10p 11.75p 13p 14.5p

*Merrill Lynch forecasts