Wednesday, July 4, 2012

Home Retail AGM - 4 July 2012

I published a detailed report about Home Retail Group (HOME) here shortly after their latest IMS, which indicated that sales at Argos have now bottomed out, and that management are comfortable with market consensus forecasts for the year. Previous HOME report.

The shares shot up about 25% on the day of the IMS, peaking around 97p, but subsequently slipped back to 80p. I should add at this point that I've put money where my mouth is, and hold a long position in these shares.

Interestingly, HOME is one of the most heavily shorted UK shares, and I reckon the shorts have got it wrong, so at some point they will become forced buyers (perhaps explaining the 25% move up as shorts ran for cover on the date of the IMS). Their pain is our gain, so bring it on!

My view, and please remember this is only my opinion, is that Argos and Homebase are both fundamentally good businesses, but the decline in sales and profits of recent years has been largely due to consumers tightening their belts with reduced spending on what are essentially discretionary items.

However, the squeeze on household incomes is now coming to an end, with inflation easing and real incomes now likely to begin modest growth after several years contraction. HOME is therefore an operationally geared play on a consumer recovery. Recent trading statements from a number of retailers have been positive (e.g,. Debenhams, Topps Tiles).

Above all, as I highlighted in my previous report, HOME has an absolutely bulletproof balance sheet, so is not only a low-risk investment in my view, but also offers deep value - which could well be outed from a takeover bid.

Consider these figures - at 86p/share the mkt cap is now about £700m, yet the business had an average net cash balance throughout 2011/12 of £320m (page 25 of the latest Annual Report), and astonishingly also owned outright its own store card operation with net debtor book of £461m! There is no corresponding debt, so the business is essentially thrown in for free! That is the type of deep value that makes me salivate, as well as sleeping well every night.

That's the background, so let's turn to today's AGM. It was held in the Jurys Inn Hotel in Milton Keynes, so I travelled up from Brighton this morning by train. The meeting was reasonably well attended, with perhaps 50 people, being mainly assorted suits (although some were Argos & Homebase senior management, on hand to meet investors), and the usual smattering of AGM pensioners!

The outgoing Chairman, Oliver Stocken chaired the meeting, and began by introducing the Board - the CEO Terry Duddy and FD Richard Ashton being the Execs, the others Non-Execs, including the incoming Chairman, John Combe, who said a few words at the end.

The CEO then gave a short speech recaping on 2011/12, making these points;
  • Difficult & challenging market conditions
  • Homebase has gained market share
  • Argos lost (slightly) market share, mainly as a result of a decline in video games consoles sales
  • Costs were flat, with savings offsetting increases
  • EPS fell 59% to 8.7p
  • No final dividend (making the 4.7p interim divi the total for the year)
  • Even more focused on costs & cash preservation
  • Argos has made solid start to Q1 of new year
  • Homebase impacted by poor weather, but held market share
  • Prioritising multi-channel (i.e. internet, mobile, and telephone)
  • Capex reducing this year to £100m
  • Argos - the last 2 quarters have seen multi-channel over 50% of sales!
  • Check & Reserve has been a success
  • Refurbing another 100 stores
  • New CEO of Argos (formerly of Best Buy) has made rapid impact already
Next came the official AGM votes, with the advance proxy votes being the only ones that mattered - and made all resolutions a fait accompli. We were all given a sheet detailing the proxy votes.

There was a 6.5% no vote against the remuneration report, so pretty muted there despite the questionable bonuses in such a bad year for profits & divis.
There was also a 20% vote against authorising Directors to allot new shares - although they stressed (as usual) that this was precautionary & there was no plan to issue new shares.

Next the Chairman invited questions, or cue eccentric/cantankerous pensioners!
The first eccentric pensioner was given a radio microphone, and pulled out a 2-page typed script, which he began to read. It rambled on pointlessly about minor operational issues concerning the pricing of a Panasonic TV at the Chichester store, you get the drift. He was humoured by the CEO & Chairman for a few minutes, then the mic was passed to me for my questions.

I flagged up the excess capital held by the business, referred to above - the excess cash and debtor book being more than the mkt cap. So I asked what plans the Directors had to unlock this excess capital - e.g. securitising the debtor book, returning cash to shareholders, etc.

The Chariman confirmed that my analysis was correct, in that the Balance Sheet is indeed very conservatively financed. They had looked at options, but felt that securitising the debtor book was not advantageous at this time. he bottom line is that they are cautious, and like having an ungeared balance sheet, and are not minded to change that any time soon.

They did point out that accounting standards might well mean that lease liabilities have to be brought onto the Balance Sheet at some point, which would increase liabilities by about £2.5bn (see below for more discussion of this point). So they want to keep things strong in that event.

I then asked a follow on question about the position with leases, in that 30% of their shops were coming up for renewal or break clause in the next 5 years, and asked whether they were able to push through rent decreases.

The FD answered this, saying that yes rents were being reduced on renewal, and that of the 30 leases renewed in 2011/12, the average decrease in rent was 16%. That's a very significant point in my view, and confirms my view that, over time profits should hold up as the rent roll reduces through renewals. The average lease term is 7 years at Argos, and 10 years at Homebase.

They negotiate with each landlord at lease renewal time as you would expect - by looking at the store's profits (or losses), and negotiating a revised rent which ensures the shop is profitable. Otherwise they hand the shop back to the landlord.

Next it was time for a cantankerous pensioner to moan about, amongst other things, the lack of a Trading Statement with the AGM. The Chairman politely pointed out that they have never issued a Trad Stat with the AGM, but regularly updated the market with IMSs. This pensioner also moaned about the cut in dividend, saying that he had been assured last year that it would not be cut.

The Chairman indicated they will consider an interim dividend in Oct 2012.

In response to another comment, it was pointed out by the Chairman that the business has changed enormously, and as the UK's 2nd largest internet retailer, many shops had become effectively customer pick-up points (plus of course getting passing trade too).

We were assured that HOME is a good business, and that it was unfortunate the share price has not performed.

Overall, my impression was of a management team who know what they're doing, and have lots of ideas for taking the business forward. They have successfully tackled the challenge of the internet, grabbing a big market share, and offering something unique with same day collection from Argos - particularly useful at peak trading periods, and for hot products.

There were no other questions (as no Trad Stat, didn't seem to be any City analysts at the meeting). We went outside into the lobby for a modest selection of sandwiches, teas/coffees, etc. I avoided the pensioners table, and instead hovered hoping to catch one of the Directors, who I was told by a pleasant lady shareholder usually mingle. She thanked me for pointing out the huge debtor book asset, which she had been unaware of.

I was delighted when the FD, Richard Ashton spoke to me (I had mentioned in one of my questions that I am a former ladieswear FD), and it turned out that we both trained as chartered accountants at the same firm, Price Waterhouse.

We had an interesting chat, and he struck me as both having an approachable manner, and clearly on top of his game.
He pointed out that their Balance Sheet strength had enabled them to pick up some good assets at reasonable prices - e.g. the Schreiber & Hygena brands from MFI, stores from Focus DIY, Habitat, etc. So they are not sitting on their hands, but are driving the business with new product initiatives, e.g.. mezzanine floors at Homebase with furniture, etc.

I did say that we hadn't really touched on what they are doing to turn the business around after a very poor 2011/12. He pointed me in the direction of a detailed presentation on their website which gives some excellent background, which can be found here (then click on June 2012 investor report).

I made the point that putting leasehold liabilities on the balance sheet is a nonsense, since that ignores the trading income from those shops! A lease is only a liability if the shop is trading at a loss. The FD agreed with me on that point.

The FD emphasised that the economic situation is unpredictable, and HOME is focused on weathering the storm & gaining market share, at the expense of weaker competitors. He gave the example of Woolworths, which used to be no.1 in toys, whereas now Argos is.

He also agreed with my analysis that many households have cut back on discretionary spending, as their incomes are squeezed and go mainly on food & energy, etc. But at some point the economy will recover, then of course HOME will see an operationally geared impact on its results.

With the share price now valuing the company at nothing (since it's cheaper than the excess cash + debtors), but still chucking out £200m+ cashflow, and trading having now stabilised, then I reckon this share represents a very good risk/reward play right now at 86p. That is my personal opinion, and absolutely not any kind of recommendation! I do not give any financial advice remember, this is a personal interest blog site only. So please always do your own research.

I shall post a link to this article on Motley Fool, and invite discussion of this share at Paulypilot's Pub on Motley Fool, here.

1 comment:

  1. Thanks for sharing this. I agree with you in many of the things you say. I think the leases are really important, and they could be the main risk if consumption doesn't recover soon, but seems to me that they are managing it well.