Primark owner Associated British Foods has conceded defeat in trying to hold prices while inflation rages but the balancing act is more delicate for electrical retailer Currys, which needs to entice cash-strapped consumers to part with higher sums for big-ticket tech products and home appliances.
Investors are unconvinced the FTSE 250 constituent can pull off this trick as successfully as it says it can — scepticism that has sent the shares down more than 40 per cent since the pandemic-era peak of this time last year and slapped an enterprise value of just 3.6 times forecast earning before tax and other charges, a near record low. Short interest in the shares has ratcheted up over the past 12 months to stand at 5.7 per cent of outstanding share capital, making the stock the third most heavily shorted in London.
The retailer, which ditched the Dixons Carphone brand last year, is three years into a transformation programme aimed at boosting the margin to 4 per cent and generating free cashflow of at least £250 million a year by 2024. To hit those goals chief executive Alex Baldock, who took charge in 2018, has an ambitious cost-cutting plan, which has involved closing all standalone Carphone Warehouse stores and reducing back and head office costs.
Efforts are being made to increase the proportion of sales made online and of services such as insurance and credit, and refocusing on its core consumer electrical, computing and domestic appliances, reversing attempts to crack the US market, capture business customers and move into software development.
But there is a risk that progress in improving margins and free cashflow could be derailed. To hit the latter target Currys needs to keep a steady rate of revenue growth, hold gross margins steady and hit £300 million in savings over the next two years.
Sales have eased from pandemic highs when consumers upgraded their tech, spurred by lockdown boredom and home working. But the 5 per cent decline in like-for-like revenue in the Christmas trading period forced management to cut pre-tax profit guidance for this year. Sales are still ahead of pre-pandemic comparisons, but the rate weakened to 4 per cent during peak trading versus 15 per cent growth during the six months before. Trading is more volatile, which could be exacerbated by consumers being squeezed more tightly by higher living costs.
Higher product costs can be passed onto consumers, but determining what proportion of overheads can be met by higher sales prices is harder, particularly if it seeks to continue its price match promise against other retailers, both in-store and online. The latter, with a lower operating cost base, have greater ability to price competitively.
Management expects £200 million of cost inflation over the next two years, but reckons it will be able to offset that with £300 million of cost savings during that time. But as yesterday’s guidance from ABF shows, cost expectations can easily creep up. What’s more, if store sales are going to justify the rent bill, then cost cuts cannot be made at the expense of any decline in service quality.
The retailer has some tailwinds. A chunk of exceptional charges and expenditure, incurred as part of efforts to chisel the group into a leaner shape, have eaten into free cashflow in recent years. The sculpting is about three quarters complete, so the removal of these charges should provide a natural boost to cash generation.
Its struggling mobile phone business, which was once losing £100 million a year, is also set to return to break-even this year. The business has shed cumbersome agreements that required it to sell a certain number of mobile contracts or face penalties from the network providers. But the odds seem skewed towards more disappointment against margin expectations.
ADVICE Avoid
WHY Inflationary pressures and falling real incomes could see profits miss expectations
Lok’n Store
Upheaval brings new business for self-storage providers such as Lok’n Store, be that house moves or businesses downsizing their office space. Trends resulting from the pandemic mean that occupancy and rental rates have both risen, the latter by almost a fifth during the six months to the end of January, as less available space allows Lok to increase prices. Higher profits also mean more cash available for distribution, which rose by more than half, and a 15.5 per cent bump in the dividend.
Higher demand has pushed up the value of the self-storage estate too, at a rate of 13 per cent on a like-for-like basis alone. The sale and manage-back of four properties at a beefy 23 per cent premium to July valuations provide further proof of strong demand. Investors expect more growth, with shares in the Aim-listed group trading at a near record high, at 42 per cent above their level before the 2020 stock market crash. But those gains also translate to a chunky premium against the company’s net asset value (NAV) at the end of January, of 23 per cent, as well as against forecast NAV of 15 per cent. True, the level of that premium is below Safestore and Big Yellow, Lok’s larger rivals, but then in an industry where brand awareness is so crucial to winning more business, the latter two groups’ greater scale could mean that their larger premium is deserved. Safestore has an element of geographic diversification via its operations on the Continent.
Investors’ thoughts will naturally turn to whether demand has reached its peak, particularly since economic growth forecasts for this year have been downgraded, which could weaken business confidence and cause the housing market to cool. In February and March, occupancy and pricing continued to move forward, up 0.9 per cent and 1.5 per cent respectively. However, analysts at the brokerage Peel Hunt think NAV growth will slow to 8 per cent next year, from an annual rate of 24 per cent for this financial year.
ADVICE Hold
WHY The shares trade at a decent premium to forecast NAV, which accounts for the near-term expected growth
