Home Retail (LON:HOME), the FTSE 250 company behind two of Britain’s best known retail chains, Argos and Homebase, saw profits fall by 60 percent to £102 million last year. For anyone in any doubt, the figures reinforced the fact that many retailers are still encountering torrid conditions on the High Street... but the problems for Home Retail run deeper than that. What’s the story? Home Retail’s 2012 prelims were not pretty. Sales at Argos (which account for 80 percent of group sales) were down by 8.9 percent and at Homebase down by 2.0 percent, together contributing to a fall in overall group sales of 6.0 percent to £5.49 billion. Argos in particular, which is Britain’s second largest internet retailer (after Amazon), was hit by a massive slowdown in consumer spending on electronics. In February, John Walden, an American with a successful track record in internet retail, was hired to run Argos and inject a new perspective on the aged brand. He has since brought in retail strategy consultants OCamp;C to rethink the strategy but the word from chief executive Terry Duddy is that the process will not end in a mass closure of stores (although some analysts have differing views on that). More immediately, declining sales and profits have led Home Retail to shelve plans for a full year dividend, leaving shareholders to make do with the 4.7p paid at the half year. While the group has committed itself to reinstating a ‘sustainable’ pay out when conditions allow, analysts have predicted that could mean at least a two-year wait for investors. Inevitably, shares in the group slumped on the results, down by 13 percent to 87p – but the bigger picture is perhaps more of a concern. The shares were trading at 222p this time last year; at which point the management had just spent 12 months and £150 million buying back shares at well over 230p (occasionally as high as 270p). The timing of that buyback has since received hostile reviews in the City. What’s the bull case? Home Retail’s supporters have argued that the group’s efforts to develop its ‘multi channel’ sales strategy will mean that it is well placed to capitalise when the economy improves. Unlike its internet-only rival Amazon, 90 percent of Argos sales involve a store in some way. Last year the multi channel approach – which, in the case of Argos, predominantly means the Check amp; Reserve service that lets consumers buy online and pick-up from the store – accounted for £1.9bn or 48% of its sales. By expanding its product lines and maximising buying scale via direct import and direct sourcing of products, the company is keen to stay competitive against the likes of the larger grocers such as Tesco (LON:TSCO), which are moving into this space. All eyes will now be on what John Walden can deliver. It is unsurprising that Home Retail is protective of its store estate given its multi channel strategy, however there does appear to be some scope to make some cost saving on this front. Between Argos and Homebase there are around 300 store lease renewals or break clauses due over the next five years (230 are Argos stores), representing nearly 30% of the store portfolio. This should give the group the flexibility to optimise the network and trim it back if necessary, which is important because… What to watch? …like many retailers, Home Retail accounts for its operating leases off balance sheet, which, on first glance, flatters the earnings. The reality is that the group paid out £363.6 million on its leases last year and the current capitalisation of those liabilities is £2.9 billion. If the businesses continued to struggle then those liabilities could have more of an impact. Elsewhere, investors don’t like dividend cuts and cancellations – and this one looks all the worse for coming just a year after a substantial share buyback programme. Critics have suggested that Home Retail misread conditions in its own markets, spending a considerable amount of its cash resources at a time when improvements in consumer spending were far from certain. Finally, the consensus among brokers was that Home Retail was already a ‘sell’ before its latest results and the uncertainty about what it will take to make Argos competitive has compounded that sentiment. The overwhelming concern among industry watchers is that the decline seen at Argos is structural and that profits will now simply keep falling unless something really radical happens. What kind of investors would look at Home Retail Group? Value hunters have been eyeing Home Retail with interest for many months because the group appears cheap on classic metrics including a notably low price-to-book valuation. Investment bloggers such a Neonomic have been encouraged by the group’s efforts to build a major online retail operation and it's certainly only these kinds of 'contrarian' investors who have been brave enough to take the long side of the trade. More specifically on a screening level, the stock qualifies for Stockopedia's James O’Shaugnessy Cornerstone Value investing strategy, which has a preference for large-cap, cash-rich stocks with high dividend yields (despite the divi suspension, Home Retail still delivered a forward yield of 7 percent based on the half-year pay-out). Indeed the share price wouldn’t have to fall much further to qualify it as a potential bargain stock under investment legend Ben Graham’s Net Current Asset Value (NCAV) strategy as based on assumptions of its assets and liabilities, Home Retail’s implied NCAV is 61.73p. But given the spectre of structural problems at Argos, the group is showing some of the hallmarks of being a value trap - the signs of which we have written about extensively. Value Traps are stocks that appear cheap because of a large price fall, but which are actually still expensive relative to their intrinsic value. These companies are experiencing a fundamental change in their business prospects and could basically be dying companies. HOME is still trying to prove that its business model isn't fundamentally flawed especially given that the high street retail sector is suffering from long term secular decline. For investors with an eye on dividends, Home Retail’s track record as a high yielding share was a serious head-turner. But this is a classic example where a high yield was a good indicator of trouble ahead - that the dividend was about to be cut. In this case, income investors have paid the price and many expect that to continue.
updated May 04, 2012
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