Home Retail: cheaper and cheaper

Perspiration, patience and procrastination

In July, I thought Home Retail (HOME) was a suitable candidate for the Thrifty 30, but I wanted to research Dixons, another potential investment before deciding whether to add either of them to the portfolio. With limited space, I probably wouldn’t want to add both, and analysing another retailer might tell me something useful.

I rejected Dixons, and then forgot about Home Retail, mothership of Argos and Homebase, which was just as well because the shares have fallen 5% to just above 200p.

This is what I liked about Home Retail:

• Value: The shares are on sale for less than 0.7 times book value, and 9 times earnings.
• Buyback: The company is buying back shares while they look cheap, probably increasing the value of the remainder.
• Trade: Judging by last year’s results, business at Home Retail was improving.
• Experience: Although the company has only been listed for four years, the ceo and finance director have been running Argos for a decade.
• Argos: The bigger of the company’s two retail chains, is different to other retailers. By hiding its stock away and operating like a giant warehouse it seems more likely to adapt quickly to retailing on the Internet.

In October, the company published its half year results maintaining the dividend, but confirming sales and margins had fallen. An earlier trading statement said the company expects pre-tax profit of £250m to 275m in the year to February 2011, compared to nearly £300m last year.

If the set-back is just the result of market conditions documented in chief executive Terry Duddy’s statement; that customers, particularly at Argos, are more reluctant to spend than in the pre-recession years and the current generation of video games consoles are old hat, then I want to take advantage of investors’ myopia. Argos will surely recover, or at least stabilise, as consumer spending does, and at 200p the shares are surely cheap.

But over the last month I’ve had good look at the competition. I haven’t been reading the annual reports of HMV, Tesco, or Amazon. I’ve been buying. I can’t say what, exactly, after all it’s not yet Christmas, but for, perhaps, the second or third year I bought all our presents online, and I realise just how much more competitive retailing is than it used to be. Online at least, everybody is trying to sell everything. You can buy laptops from Homebase, which is really a garden centre and DIY chain.

Take the Sony PlayStation 3, available at Tesco, Amazon, Argos, Game, HMV, John Lewis, any of the other places you’d traditionally go and a variety of less well known Internet upstarts. You can look up the prices, check stock and delivery items, and the games and controllers that are bundled with it. It’s fantastic, unless you’re a retailer locked in a constant price and service war. But does it really matter which company you go to? Some retailers have Super Saver delivery, some earn you Clubcard points, but the biggest factor in most peoples’ decisions, when shops are just one click away, is surely price.

No wonder sales, and margins, are under pressure. Although Argos has a reputation for value and already makes 32% of its sales on the Internet, mainly through its Click and Collect service, my Christmas shopping has given me something else to worry about.  Maybe retailing’s getting harder, for all, permanently.

Home Retail’s strength could be in the breadth of its product range, some of which may not be so easily commoditised. This page on its website contains a breakdown showing the combined forces of Home Retail are market leaders (by various measures)  in housewares, furniture, small domestic appliances (hair dryers and toasters) toys, jewellery and sports and leisure equipment.

Much as I like Argos, I’d rather the company were so cheap it wouldn’t matter if it were less profitable in the future than in the immediate past. The fact is, though, its book value is 58% goodwill. Goodwill, typically the money paid for acquisitions over the cost of the physical assets acquired, is notoriously hard to value especially if the businesses concerned could be less profitable in the future. Strip out the goodwill and the shares cost 1.5 times tangible book value, which, though far from outrageous, is less attractive.

Looking at the data, Home Retail is in a probabilistic sweet spot. The shares are cheap, and the company looks profitable and strong. But there are doubts about each one of those factors so I’m going to remain cautious until Home Retail publishes its results for the year ending February 2011.

By then there may be less competition for space in the portfolio, as I remove companies that reach their targets. In addition to Waterman and Dewhurst mentioned in the last monthly review, Trifast, Triton, Holders Technology, Johnson Service, and Castings are all near or beyond the 50% profit level at which I consider them for eviction.

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