Even though the economic climate in the UK for home improvement is unlikely to pick up any time soon, there are signs that this DIY chain is turning the corner by improving its execution.
Tip of the week: Kingfisher (KGF), rated as overweight by Lehman Bros
Kingfisher is Europe’s biggest home improvement group and the third largest in the world, with number one positions in the UK, France, Poland, Italy, China and Taiwan. Its main retail brands are B&Q and Screwfix in the UK, and Castorama & Brico Dépôt in France. Sales for the year ended February 2007 were £8.7bn, of which half was generated overseas – delivering underlying earnings per share of 11.9p and paying a chunky 10.65p dividend (5.9% yield). Although the cover is thin, the dividend is underpinned by the firm’s £3.2bn freehold property portfolio, equating to 58% of the group’s enterprise value (that is, the sum of Kingfisher’s £4.2bn market capitalisation and £1.3bn net debt).
That’s all very well. But how is current trading in light of higher global interest rates and the softer UK property market? Last week, Kingfisher reported interim results for the first half of 2007/8 slightly above City hopes. Total like-for-like sales were up 4.7%, with strong performances from abroad, especially in Poland, offset by sluggish growth of 2.0% from B&Q. Even so, B&Q’s results trounced its rivals; Homebase last week reported a 2.5% slump in first-half like-for-like revenues.
The trend in like-for like sales is positive: rising from –7.8% in 2005/6 to –2.9% last year, and now +2.0% in the first half 2007/8. This has been driven by better merchandise and the revamp of larger stores, where sales densities have risen to more than £200 per square foot, or 30% higher than their predecessors. As most outlets are still in the old formats, there is plenty of scope to improve profitability above current operating margins of only 3.6%.
As part of the turnaround, Kingfisher is also polishing up customer service, with 800 staff attending a week-long decorating course to improve their DIY knowledge. The group also confirmed that it planned to drop B&Q’s “You can do it” strapline after almost two decades. Chief executive Gerry Murphy said B&Q was increasingly targeting a new generation of “Do It For Me” customers. He also announced that B&Q was developing a new internet service that would allow customers to order online and then collect from the store.
The City is forecasting 2007/8 sales and earnings per share to be £9.3bn and 11.7p respectively. At first sight the p/e ratio of 15.5 looks about fair, but this ignores the B&Q turnaround. Assuming UK operating profit margins of 5% are realised by the end of 2009, then earnings per share of around 17p should be achievable. On a 15 times earnings multiple, this would equate to 255p per share in two years. Add the 22p of future dividends, then the total pre-tax shareholder return should be more than 50%.
So what do we need to watch out for? The main risks surround the B&Q upturn, together with a tough economic backdrop in the UK. But with such strong brands, good geographical diversification and a healthy dividend yield, I believe Kingfisher’s stock is a long-term buy for the income investor. Even if management does not deliver, I could see Kingfisher being swallowed by a larger rival, such as Home Depot or even Tesco, which may wish to enter this sector. Lehman Bros has a 245p target price on the stock.
Recommendation: long-term BUY at 171p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments