WH Smith: two companies in one

The recent award of the 2018 and 2022 World Cup football tournaments to Russia and Qatar prompted the cynical quip that demand for brown envelopes must have been high close to FIFA's Zurich HQ. Pity then that the stationery giant, WH Smith, doesn't yet have any outlets in that city.

That may change, however. In recent years the retailer, which has been present on the UK's high street since 1792, has once again started to expand overseas, opening stores in Scandinavia, India and Australia to add to outlets in France and the Republic of Ireland.

This isn't the first time the group has embarked upon overseas adventures. It sold its operations in the US and Asia Pacific in 2004 shortly after the arrival of its current boss, Kate Swann, as chief executive in 2003. Back then, the overseas operations, which had been hit hard by the effects of 9/11 and Sars, weren't delivering. But, with passenger numbers rising, the timing of a renewed overseas expansion looks good. The group now has 17 non-UK stores, and will open another 12 in 2010-11. Some new openings will be under a low-risk franchise model.

As well as the overseas opportunity, WH Smith is finding scope to expand its so-called travel division in the UK. After putting newsagents into motorway service stations, it is now looking to build up its position in hospitals and workplaces. The acquisition of Yorkshire-based United News for £19m in 2008 brought it critical mass in the hospital market, of which it now has a 10 per cent share, and it hopes to add another 50 to the current base of 103 outlets as contracts in this fragmented market are re-tendered over the next five years. Management also reckons 40 news sites could be added to its small offices business.

The expansion of the travel division is important because the UK high street stores look ex-growth, with sales having fallen at an average of 5 per cent a year for the past five years, and expected to fall at 2.5 per cent a year for the next three. Although travel's like-for-like sales have also slipped over the past two years, new space has kept turnover ticking up, even before a recovery in air passenger volumes. Sales in the division have risen at an average of 7.8 per cent a year over the past five years, while improvements in gross profit margins mean that profits have grown even faster, overtaking those of its high-street business for the first time this year. However, it's crucial that group sales keep ticking up because the scope to widen margins further is now limited.

True, part of the sales decline is the result of shifting the sales mix towards more profitable lines, with the exit from entertainment - CDs and DVDs - the most important contributor to improved profitability. Entertainment once accounted for a quarter of sales, but now accounts for just 4 per cent. Simultaneously, the proportion of higher-margin stationery has increased.

Cost cutting has also been critical and, although £87m has been taken out of the business since 2005, a further £25m of savings have been identified over the next three years. Good retail discipline also means the business remains highly cash generative. Broker Shore Capital expects net cash balances to more than double to £133m by 2013, even as capital spending and dividend payouts increase.

City analysts increasingly view WH Smith as two distinct businesses: high street and travel, that could be separated to crystalise value. This vew is not without foundation - Kate Swann has turned to demergers to unlock value in the past; namely carving out Smith's newspaper wholesaler, Smiths News, into a separate listed company. High street and travel are already managed independently and analysts value them at 540p per share on a sum-of-the-parts basis, with the faster-growing travel business accounting for two-thirds of that.