SHARES: Farepak prepares for feeding frenzy

One of the most important decisions for a company is what to do with its cash. In the 1980s many companies enjoyed fast-rising profitability, but lost the opportunity to reward shareholders by indulging in an orgy of over-priced acquisitions. Food hamper group Farepak has a cash-generative core business, but the money has not always been deployed wisely. Unsuccessful ventures include a short-lived move into the travel business and the purchase of a meat- processing operation, Transfood, which has absorbed investment while mostly making losses. But there have been some far better deals, including last year's purchase of a doorstep catalogue sales operation, KleeneZe, which is shaping up as a major coup.

There is a case for saying that Farepak needed a deal. Its main business consists of sending Christmas hampers via a network of agents who collect the cash in advance. This business has grown strongly over the years, driven by rising agent numbers. But new agents are harder to come by. The total fell last year and is only up fractionally in 1996. So, although the cash machine keeps pumping, some of the oomph has gone out of the growth of earnings per share.

The tougher trading background can be seen more vividly in the case of Farepak's main rival, Park Foods, where the shares have more than halved from their 1994 peak, hit by a steep fall in 1995-96 profits. Farepak's plight is nothing like so severe, but the past 12 months have been uncomfortable. Business, particularly at Transfood, was hit by the BSE scare, producing a pounds 360,000 loss against break-even the previous year. The contract packing division has been hit by the loss of its main third-party contract, which mail order giant GUS is taking in-house. Chairman Bob Johnson reckons that will hit current-year profits by pounds 500,000. Lastly, the KleeneZe deal, done at a time when rival Betterware's market capitalisation had collapsed to around pounds 40m against a peak pounds 250m, looked a risky move to some investors. Farepak's shares slipped from a peak 393p to a low of 28lp.

But it is increasingly clear that the fall was overdone and the shares have rallied to 355p. BZW analyst Geoff Douglas expects earnings per share to reach 24.3p for the year to April 1997 and 27p the following year against last year's 22.7p and 20.5p the year before. The prospective PE is still only 14.6 for a group which has more than quadrupled earnings in the past nine years, with turnover greater than pounds l00m against a market capitalisation of pounds 82m and with cash balances which range from pounds 10m to a peak pounds 60m just before hamper deliveries begin in the run-up to Christmas.

When Farepak bought KleeneZe for pounds 9.2m, with a further maximum deferred consideration of pounds 3.4m, in the summer of 1995, shares of rival Betterware were flat on their backs at 40p to capitalise the group at pounds 42m. Since then they have recovered to 121.5p and chairman Andrew Cohen is sufficiently confident about prospects to have acquired a further 598,000 shares at 12lp. Suddenly, doorstep selling is looking like good business again.

Farepak management is already having an impact on the KleeneZe business, with sales running up 35 per cent on last year's pounds 22m-pounds 23m and agents being recruited at double the rate achieved a year earlier. Measures taken by Farepak include halving the number of overseas suppliers and stepping up the agent recruitment programme through conferences.

Last year, KleeneZe made pre-tax profits of pounds 1.1m, after financing costs, on sales of pounds 22m for nine-and-a-half months. This year, sales for a full year should be heading for pounds 33m-plus, so every extra point on margin adds at least pounds 330,000 to profits. The long-term goal, which looks highly achievable, is to double margins to 10 per cent. As KleeneZe is performing so well and Transfood is moving from losses, perhaps to a modest profit, current-year profits could be nearer pounds 9m than the forecast pounds 5m, giving a further lift to the share price.