SILVER BULLETS - Espirito Santo Investment Bank incorporating ...

THIRD QUARTER 2010
Home Retail Group
Far from Home
Home Retail Group management has affirmed that it expects to be
able to drive a “similar level of profitability” to last year despite the
disappointing performance from Argos in the first quarter. Consensus
estimates reflect this confidence and whilst forecasts have fallen 7%
since the 1Q IMS in early June, we would argue that consensus
estimates are still too bullish, particularly for 2011/12. Structural
pressures remain and as a 100% UK consumer-exposed stock, we
reiterate our Sell recommendation and downgrade our fair value to
175p, at which the shares would trade at 9x our cal 2011 EPS.
Share price underperformance to continue in our view
Home Retail Group shares are down 21% (18% relative to the SXRP) in the past
quarter, vindicating our decision to include them as our Silver Bullet Sell in 2Q10,
but perhaps raising the question as to whether including them for a second
consecutive quarter is advisable. Trading relative to peers suggests that the
company is suffering from both structural and cyclical pressures and with our EPS
estimate 27% below FY12 consensus, we still think the shares represent both an
excellent absolute and relative short with the 2Q IMS on 9 th September a potential
catalyst. What’s more, Home Retail Group is currently one of the smallest stocks in
the FTSE100 and risks dropping out of the index (and the associated index funds)
in the September review.
Likely further pressure on consensus forecasts…
We had assumed that the World Cup would provide a small boost for TV sales, but
Argos seemingly saw no such benefit (in stark contrast to its specialist
competitors). We feel this could be an early sign of structural pressures facing the
business as the market polarises between low-priced commodity products and
high-priced service-led products, leaving Argos squarely in the middle with little
point of differentiation.
Given the weakness in both vision and gaming, we admit to being slightly
perplexed by the company’s affirmation that it expects to see a “similar level of
profitability” to last year (although it is unclear if this guidance refers to absolute
profit or a profit margin). In an attempt to stress-test our assumptions, reverseengineering
consensus PBT of £276m implies a LfL sales deterioration of c..2.5-3%
at Argos (assuming gross margins in line with guidance – down 50bps). This is
where we take issue, particularly given the comps become more difficult for the
next TWO quarters and hence the implied 2-year LfL is demanding. We expect this
to become increasingly evident as we head into the 2Q IMS statement on 9 th
September and note that we are looking for a LfL sales decline of 5% in FY11.
Given the ‘delay’ to the proposed increase in VAT (the 20% rate will come into
effect 4 Jan 2011) it was plausible that we would raise our FY11 LfL sales estimate,
but we are sufficiently concerned that trading will remain difficult that we have left
this assumption unchanged. We have instead lowered our 2012 LfL sales estimate
with a corresponding fall in our PBT forecast; we now look for £218m of PBT, 27%
below current consensus.
Valuation not compelling even with attractive dividend
Thus whilst the consensus valuation of 8.6x cal 2011 EPS might look appealing
given the historic valuation of the stock (12.3x average since demerger in
November 2006 but as low as sub 7x consensus EPS in 2008), we remain far from
convinced on the value proposition. On our new lowered forecasts the shares trade
on 11x our cal 2011 EPS whereas we believe the fair value should be closer to 9x
given the declining earnings momentum. As such we lower our fair value to 175p,
implying 17% downside, and retain our Sell recommendation.
http://www.execution-noble.com
SELL
17% downside
Fair Value 175p
RIC, Bloomberg Code HOME.L, HOME LN
Share Price 210p
Market Capitalisation £1,832m
Free Float 99%
Year to 3 Mar, £m 2010 2011e 2012e 2013e
Sales 6,023 5,876 5,776 6,012
PBT 293 245 218 274
EPS (p) 23.1 20.2 18.8 24.4
Dividend (p) 14.7 14.7 14.7 16.2
FCF*1 262 124 82 259
Invested Capital 3,080 3,124 3,196 3,139
Net Debt/(net cash)
1. Post capex
-414 -268 -231 -358
Year to 3 Mar, x 2010 2011e 2012e 2013e
EV / Sales 0.24 0.27 0.27 0.26
EV / EBITDA 3.4 4.3 4.7 4.0
PE 9.1 10.4 11.2 8.6
Dividend Yield (%) 7.0 7.0 7.0 7.7
FCF Yield (%) 14.3 6.8 4.5 14.1
ROIC (%) 6.2 5.4 4.7 6.0
Net Debt / EBITDA -1.0 -0.7 -0.7 -0.9
Analysts
Caroline Gulliver
+44 20 7456 9173
caroline.gulliver@execution-noble.com
Robert Evans
+44 20 7426 4210
robert.evans@execution-noble.com
Richard Cathcart
+44 20 7456 9155
richard.cathcart@execution-noble.com
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