I’m not a big fan of the retail sector owing to my concerns over consumer spending, tax increases and public spending. However, there are always exceptions to my rule, especially where a company is already pricing in near-extinction.
Take DSG, the pan-European electrical chain that owns Currys, Dixons and PC World. In December 2008 the shares were at 9p and the firm was on the brink of visiting the corporate Grim Reaper. Eighteen months later, after raising £310m via a placing at 30p and a rights issue at 14p, DSG is back on track. Indeed, at last week’s trading update, CEO John Browett, who earned his spurs at Tesco, announced a 6% lift in like-for-like second-half sales, which blew the cover off its nearest rival, Comet.
But what has particularly caught my eye is that Browett seems to have “got it”. Unlike many of his peers, DSG is not mindlessly expanding its store base. Instead, it is shrinking its estate of 664 outlets to 500, upgrading those left into specialist/mega stores that showcase new technology, and ramping up its internet presence (which already comprises 11% of turnover).
This way, not only will profitability recover and tick back up to industry norms of 3%-4%, but sales should also rise as more punters first experiment with, and then buy, cutting-edge gadgets from the likes of Apple and Microsoft. And with demand for Windows 7 PCs, 3-D TVs, netbooks and energy-efficient white goods set to remain robust, DSG’s refitted stores, better service offering and wider product range should be a hit.
In fact, turning the clock forward a couple of years, I believe that with continued tight cost control the group can deliver sustainable Ebita of £270m per year on turnover of £9bn by 2011/2012. So using a ten-times multiple – and adjusting for net debt of £220m, a £292m pension deficit and discounting back at 12% – I derive an intrinsic worth of about 48p per share.
Fine, but what are the possible bugs? Well, competition from the likes of Argos, the supermarkets, Amazon and Best Buy is intense. Additionally, borrowing levels need to be monitored – although with a comfortable loan to Ebitda ratio of less than one, a further equity raising seems unlikely. With the fillip from the football world cup next month, DSG looks a good bet for the more adventurous investor. Preliminary results are scheduled for 24 June.
Recommendation: SPECULATIVE BUY at 26p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments