Tough times strike Home Retail

Home Retail – which operates the high street catalogue retailer, Argos, and DIY group Homebase – is having a tough time. Its trading update for the second quarter of 2010-11 revealed plenty of pain, with chief executive Terry Duddy warning that the group’s first-half profits, which are due for release on 20 October, will be 20-25 per cent down on last year’s outcome.

Admittedly, Homebase’s performance has been a shade better of late. Its like-like-sales were 1.4 per cent down on the year in the first quarter, but recovered to be flat on the year in the second quarter. Uninspiring though that seems, it was better than some of its rivals. "With B&Q and Wickes both seeing a slowdown in the run-rate of bigger-ticket items, it was encouraging to see [Homebase] ahead on kitchen, bathroom and bedroom," said Andrew Wade, an analyst at broker Numis Securities. But Homebase's second quarter gross profit margin fell 75 basis points, and any resilience at Homebase was thoroughly overwhelmed by a grim performance at Argos, which generates about 70 per cent of the group's sales. After sliding 8.1 per cent in the first quarter, Argos's like-for-like sales slumped 5 per cent in the second quarter, and its second quarter gross profit margin tumbled 125 basis points.

Investors shouldn’t expect that performance to improve anytime soon, either. The latest figures from the Office for National Statistics reveal that, far from continuing to recover, retail sales fell in August – down 0.4 per cent year-on-year. Hard pressed consumers could yet retrench further given the government’s austerity drive, a concern that wasn't so prominent when Homebase announced its full-year figures in April. It’s a concern that Mr Duddy is reported to have flagged when commenting on the trading update, saying that confidence or spending could still be hit by the government's spending review that’s due next month. Indeed, it's thought that departmental budgets could face cuts of up to 40 per cent, potentially taking a huge amount of spending out of the economy; while the associated rise in unemployment, as public-sector workers are laid off, hardly bodes well for longer-term consumer sentiment.

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That tough backdrop has left Home Retail's growth prospects looking bleak. In fact, broker Charles Stanley cut its estimate for full-year adjusted earnings by 8 per cent to 21.8p on the back of the update (see table). That leaves the broker expecting underlying earnings to slide by 7 per cent in the year to end-February 2011. And the broker forecasts earnings growth for 2011-12 of just 1 per cent. "Forecast risk probably remains on the downside," notes Charles Stanley's analyst, Sam Hart.

Still, it’s not all bad news and Home Retail has, for example, made a big effort to cut costs. Management had originally anticipated that first-half savings of £15m would be offset by a £15m cost rise in the second half. But that has since been improved upon. Alongside the trading update, management said that savings of £30-£40m had been generated in the first-half, with a flat cost outcome anticipated in the second half, making net cost savings of £30-£40m for the full year. The group boasts an impressive cash pile, too. It had £414m of cash and no debt at the end of February, though broker Numis Securities thinks that will fall to £219m by February 2011.