January was an awful month for the FTSE 100, which fell 9%. Some of the worst punished were retailers, especially those who missed targets. But this stock escaped the carnage, even though its third quarter results missed City hopes. But it’s only bid speculation that’s keeping it afloat.
Carphone Warehouse (CPW), rated OUTPERFORM by CSFB
Revenues were 4% below analysts’ forecasts, despite the launch of Apple’s iPhone in November. So why, given the City’s current unforgiving mood, has the stock remained broadly flat? In short, bid speculation. The latest rumour is that Best Buy of the US (which already owns a 3% stake) is mulling a bid at 420p a share. But I can’t see Charles Dunstone, the founder and CEO, selling his baby anytime soon. And why would Best Buy want to take on more high-street outlets at a premium price, just when UK consumers are buckling under a mountain of debt? Rather than being evidence of takeover ambitions, I suspect the 3% stake was negotiated away by Carphone Warehouse in return for Best Buy promising to fund the rollout of their joint marketing deal in America. If I’m right, and the logic fits with the firm’s tight cash position (see below), then the shares are heading for a tumble. Here’s why.
Firstly, the stock trades on 16 times earnings, a 60% premium to its high-street neighbours. Next, the business is loaded with £763m of net debt, and has high fixed costs due to store rents and employee salaries. This will put a brake on earnings growth as the economy slows. Thirdly, the mobile and fixed-line telecoms sector is unhealthily competitive. With so much money being pumped into the launch of bundled services from the likes of Orange, SKY and BT, I can’t see how this won’t end up in tears. The cost of broadband has already fallen sharply. The consumer will be the main beneficiary from this “dotcom-like land-grab”.
Finally, due to the large amounts of capital expenditure Carephone Warehouse is incurring to install its own equipment in BT exchanges (known as ‘local loop unbundling’), cash flow is set to remain negative in the near term. As such, Carphone Warehouse’s lack of financial muscle and heavy debt load will mean it lacks the fire-power to compete with its much bigger rivals. Therefore, owing to the company’s inflated valuation and heavy reliance on the UK consumer as the retail climate becomes tougher, I advise shareholders to sell. There is better value elsewhere. The next trading update is on 14 April 2008.
Recommendation: SELL at 302.5p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments