This feels like rather a neat post to write, given the last two 'topics' - last Wednesday on Morgan Sindall, and their 'huge' returns (mostly driven by working capital management and Friday pontificating on what returns on capital actually mean for an investment. So I swing over to the other end of the spectrum, to a company arguably at the bottom of its cycle and a rather popular share with value investors - Home Retail, who own Argos and Homebase.
I say 'bottom of its cycle' as a current and more forward looking thing, really, because one thing that did surprise me when looking at the company's accounts was how well it held up during the recession in general. Apart from a big asset writedown, as you can see on the graph, profits have actually held up rather nicely. It was only 2012 that saw that figure dip heavily, but forecasts are for a continuation of that - these very weak figures - instead of any return to their profit in, say, 2010. Which course of events is more likely?
I consider Home Retail more of a 'bigger picture' investment question. As far as I'm concerned, there's a sort of investment continuum between risk - there's companies whose primary risks are more idiosyncratic, and rooted entirely in how that specific business operates, and there's companies whose performance is determined more by market forces. Of course, no-one can escape market forces - but take something like Communisis and compare it to Home Retail and you'll see what I mean. The latter is a huge part of the general retailing market, and as such is primarily driven by general consumer confidence. This makes company specific trends more difficult to interpret. The first is facing a market of uncertain potential size, with a relatively new offering of services.
There's two primary questions I'm concerned with relating to Home Retail, and they're (as always) interrelated. The first is probably the most obvious - it's clear times are rough for the consumer, but how much of the downturn is cyclical and how much of the downturn is secular? I can't remember the last time I bought anything from Argos. I use other internet retailers (nearly always Amazon) for almost everything. On the other hand, when was the last time I bought a real big-ticket item? Perhaps it's more indicative of my perception than anything - apparently nearly 40% of Argos's sales are now made online. This shifts the focus slightly. How synergistic are the two sides of Argos's operations? Does having their large stores help to drive customer awareness, and improve profitability online - or is it simply a case of increasing overall costs so they can't effectively compete with the super-light business models of the purely online retailers? I suspect the latter, frankly, though there's at least some evidence for the former - and clearly a good deal of customers like having the actual shops there.
The second question is this - how fixed are their costs? Something I think people often overlook with relation to retail is that the cost line can move, too. If Argos are in a strong competitive position on the high street, if the 'high street' as a unit is flopping, why is there the assumption that costs will stay the same? It seems likely to me that at least the rent portion of Argos's costs (and a significant chunk they are, too) should be able to come down significantly when the contracts come up for renewal. The problem is just one of short-term stickiness on prices. There has to be some benefit for returns accruing to Home Retail from the fall of their competitors, and the general trend toward having fewer outlets.
If we pencil in any return to pre-recession returns - which might be plausible if we assume they come out of this having restructured, renegotiated their lease payments and with a stronger (and probably more digital) multi-channel offering, the market cap looks cheap. They seems to be managing leases fairly well, which gives us some feel of safety on that side of things - leases are basically a form of debt, remember, and if things go wrong they simply amplify the speed at which the dominos fall over.
I'm still reserved on Home Retail, though. Maybe it's fair to say that while I think it's got better odds than the market seems to be pricing, I think there's better picks still further down the market-cap chain - stocks whose outcome rests on more company specific factors. Perhaps I'm just having trouble seeing what value Argos really provide. I never shop there. That shouldn't influence me - I never buy polythene or kitchens, but I'm still invested in British Polythene and Howden Joinery - but I suspect it might, on some level.
Filed Under: Value Investing,