Sunday share tips: Direct Line, Paragon, Hornby

30th Sep 2012 18:38

RBS is floating Direct Line to comply with rules on state aid - and private investors can buy the shares. But should you? The disposal by RBS has to start this year, with the majority of Direct Line sold by 2013 and the entire business by 2014. The initial plan is to sell 25 per cent, with a further 5 per cent sold if demand is strong. This means significantly more shares will be issued over the next two years. The price range is 160p to 195p, valuing the float at 2.66bn pounds at the mid-point. This is lower than analysts' valuation of between 3bn pounds and 3.2bn pounds, implying the issue has been "priced to go". Not all units are profitable, however. Furthermore, on Friday, the Office of Fair Trading (OFT) referred the UK private motor industry to the Competition Commission. This has put a question mark over the profitability of its motor business, which represents 42 per cent of the group's premiums.The insurer has committed to distribute 50 per cent to 60 per cent of after-tax profit as a dividend. Based on expectations of a 2012 operating profit of 450m pounds, this implies a payout of about 10p to 12p, or a yield of up to 7.5 per cent. With interest rates expected to be low for some time this is very attractive and should help support the price through future share sales. With a yield this impressive the offer looks good and the lower-than-expected valuation goes some way to discount risk from the OFT investigation. "With some reservations," The Sunday Telegraph´s Questor team says to buy a small stake.Buy-to-let is back and for investors wary of becoming a landlord, the Paragon Group could provide a slice of the action. The group's potential was underlined last week when it said it had secured a new line of borrowing from Lloyds for £200m. This will provide the capital for a further bout of lending by Paragon that has seen its mortgage book swell in recent months. A new boom in buy-to-let has allowed Paragon to lend £137million in the nine months to July, up from £96m in the same period in the previous year. That was funded mainly by a short-term loan facility from Australian bank Macquarie, which is being renegotiated. Analysts expect a positive announcement on that line of borrowing within a couple of months. So what has all this meant for Paragon's profitability? At the financial half-year mark, pre-tax profits were £44.8m, up from £39.5m for the same period in 2011. For the full year to today, the market consensus is for profits of £91m, up from £81m last year. For the above reasons the Financial Mail on Sunday´s Midas column concludes that: "A sudden turn in the housing market would pose a serious threat to Paragon but current trends are positive and the group's valuation is modest. At 2061/2p, the shares are a buy, but keep an eye on the economy and housing market for signs of weakness."Hornby is an iconic British company selling brands such as Scalextric, Airfix and, of course, its eponymous model railways. Its shares fell almost one third last week after warning of weak Olympic sales and serious supply chain issues. Management now sees full-year profits at "break-even", down from a consensus view of just under £6m. The more serious aspect related to supply issues in China. One of the group's major manufacturers in the country is rationalising its facilities and "substantial" disruption is expected. Hornby faces a challenge of finding a new, cheap manufacturer. This is achievable, but it is a situation that is unlikely to be resolved in short shrift. The challenging retail backdrop since the financial crisis has resulted in weak trading at the group during its make-or-break Christmas trading periods. Questor sees no reason to hope for a stellar Christmas this year either. Yet once the company resolves its manufacturing issue, the medium term looks bright. The shares are certainly cheap - but they are cheap for a reason. It will take some time for the supply chain issues to be resolved. Until we have signs of hope on this front, Questor says avoid.Please note: Digital Look provides a round-up of news, tips and information that is impacting share prices and the market. Digital Look cannot take any responsibility for information provided by third parties. This is for your general information only as not intended to be relied upon by users in making an investment decision or any other decision. Please obtain a copy of the relevant publication and carry out your own research before considering acting on any of this information.