If you are thinking of buying shares in the UK’s largest seller of carpets, then virtually everything you hear or read about the company right now is telling you to steer well clear.
Selling carpets is a cut-throat business. Customers are always looking for a deal and plenty of sellers seem willing to cut prices to give them what they want. This makes it hard to keep your head above water when you have to carry the costs of renting stores and the staff that work in them.
Rival Allied Carpets went bust three times in three years before someone bought the remaining scraps of it in 2012.
Carpetright (LSE: CPR), however, has survived and has a sizeable 25% share of the £1.5bn UK market. Yet, this business has so many red warning flags flying from it, it’s not really surprising that lots of people are betting that the shares still have a long way to fall from their current 52-week low of 373p.
Last year, the chief executive walked out of the business. This year, the company’s founder, Lord Harris of Peckham, has announced that he is planning on leaving and has been selling quite a lot of his family’s shares recently – shifting over £13m worth a couple of years ago. A venture into Europe has not paid off and is losing money.
What’s more, profits have fallen a long way. Back in 2010, its trading profits were £34.1m and its operating margin was 6.6%. A decade ago, profit margins were in the low teens. Not looking good when you contrast that with last year’s UK profits of just over £10m and margins of just 2.5%. So why on earth would you think about buying the shares?
Well, an investment only makes sense if you think sales will eventually increase. Despite its woes, Carpetright still makes over 60p of gross profit for every £1 of carpet it sells – a level of profits which hasn’t really changed for years. The trouble for Carpetright is that once the costs of its stores and staff are taken away there isn’t much money left over – it needs to sell a lot more carpets.
If it can sell more carpets for a profit of 60p in the pound then there’s scope for profits to go a lot higher, as lots of costs are fixed. (That said, the normal correlation between mortgage approvals and carpet sales seems to have broken down at the moment.)
Costs can come down from closing loss-making stores and renegotiating rents on about a fifth of the ones that remain. This is the bet that renowned value investor Franklin Templeton seems to be making. It has been buying lots of shares and is now the largest shareholder with a stake of nearly 20%.
Verdict: a very risky punt