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Home Retail Group: Bid Approach by Sainsbury

Steve Clayton | 6 January 2016 | A A A
Home Retail Group: Bid Approach by Sainsbury

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Sainsbury have revealed that they approached Home Retail Group in November, proposing a cash and shares merger, but were rebuffed. Sainsbury are considering their position and could table a formal offer. Takeover Panel rules dictate that any such offer must be made by 5pm on February 2. The terms of the original proposal have not been disclosed by either side.

The comment and view below represent our thoughts on Home Retail as a stand-alone entity, written before the merger approach was revealed.

Shares fall over 10% following interim results - 21.10.2015:

Interim results from Home Retail group show a solid performance from Homebase, a mixed outcome from Argos leading to an overall increase of 10% in benchmark profit to £34.1m. But this is accompanied by a warning that whilst the interims might be ahead of last year, tough trading conditions for Argos's electrical and seasonal products ranges, and an uncertain customer take-up of Argos's new Fast Track delivery services suggest that the full year outcome will likely be slightly below the bottom end of current market expectations, suggesting something below £115m.

Home Retail Group shares fell 10% in early trading.

Our view:

Home Retail is a highly speculative situation. The business owns an also-ran in the home improvement market and the High Street retail format most exposed to the growth of e-commerce titans like Amazon and eBay. It makes negligible profit margins and is having to invest heavily to reinvent itself as a digitally astute, fast-fulfilment specialist, capable of getting online orders to your door in hours, not days. The balance sheet has significant leasehold obligations and there is little concrete evidence that Argos is winning the battle.

You do get a lot of sales per share with Home Retail; the stock trades on a Price/Sales ratio of around 0.2x, which is low by retail standards. But it will only act as a support if the group can lift the profit margins it can earn. Today, Argos is warning that the costs of investing in Fast Track mean that the margin is under pressure, not recovering.

There is uncertainty too over Black Friday and Christmas. Last year, Black Friday saw retailers rushing to cut their own throats, by over-discounting, pulling volumes forwards from December, but destroying the profit margin they would have earned had normal pricing discipline prevailed.

Forecasts look likely to drop by 10-15%, though we notice one broker has already reduced their forecast to just £90m. If Fast Track eventually becomes wildly popular, and if it can be delivered at a price per parcel that covers its costs, then maybe, one day, Argos may have a bright future. But at the moment, we find it impossible to have any confidence in such an outcome.

The interim dividend was maintained at 1p per share. If the company also maintains the final dividend, set at 2.8p last year, then the stock will offer a yield of 2.5% based on the closing price on October 20 of 150p. The Home Retail payment is at least still well covered by current market earnings expectations, even after the downgrades today however dividends are variable and not guaranteed, especially when company profitability is under pressure.

Trading and Strategic Details:

Argos pushed ahead with its transformation plan; 86 digital concessions were opened, more than doubling numbers. 45% of sales were via digital channels, with a quarter of sales now made over mobile devices.

Fast Track, their new service proposition involving rapid in-store collection or home delivery launched after the half year end.

Homebase closed a further 25 stores and accelerated a cost reduction programme.

Like for like sales were -3.9% at Argos, and operating margins were just 0.4%, with the extra Fast-Track investment offsetting an underlying improvement in gross margins.

LFL sales at Homebase were up 5.6% and operating margins rose 90bp to 4.2%, despite a 125bp decline in gross margins. Selling space was 2.1m square feet (or 14%) lower than last year. The costs of the store closures are offset by an agreement to sell a site in Battersea for £57m.

There was a £115m cash outflow in the period, largely due to adding £95m to trade working capital as the business increase stock levels to handle Fast Track deliveries.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.