WH Smith has endured five years of falling sales while the UK has been mired in its on-again-off-again recession. But, during this time, the stationery, books and mags retailer has produced double-digit EPS growth every year without fail, while returning nearly a third of its current market cap to shareholders through dividends and share buybacks (see table). And with the outlook for key end markets finally starting to improve, a 4 per cent yield on offer, net cash on the balance sheet and a derisory rating compared with peers, it looks like a prime time to buy shares in this overlooked retail sector star.
- UK air passenger numbers increasing
- Organic growth potential in travel
- Overseas expansion
- Dividend yield
- New CEO has yet to prove himself
- Shares have already had a good run
Big returns from falling sales
| FY to 31 Aug | 2009 | 2010 | 2011 | 2012 | 2013* |
|---|---|---|---|---|---|
| Sales growth | -0.9% | -2.1% | -3.0% | -2.4% | -3.2% |
| Underlying EPS growth | 17% | 11% | 12% | 22% | 11% |
| Buybacks | - | £35m | £55m | £50m | £50m |
| Dividends paid | £23m | £26m | £29m | £31m | £34m |
Source: Company, S&P CapitalIQ and Bank of America
*BoA forecast growth rates, buyback announced 23 Aug 2012
WH Smith (SMWH) has achieved such strong earnings growth thanks to cost-cutting, under the stewardship of former chief executive Kate Swann, while using strong cash generation to fund buybacks that have significantly reduced the number of shares in issue. Indeed, after £24m of capital spending in the first half, free cash flow came in at £58m, which comfortably funded £22m of share buybacks and a £23m dividend payout. And, while a company can't slash costs indefinitely, WH Smith should be able to carry on until sales rebound, which some analysts believe will happen in 2014 or 2015. Such a lean business structure means an uptick in revenue should translate into even tastier returns.
The travel business - shops located in travel hubs - offers the biggest potential for sales growth. In the 2012 financial year, travel accounted for 37 per cent of group revenue and 54 per cent of operating profit. A store opening programme is charging ahead and a catalyst for growth is starting to emerge in the form of rising UK air passenger numbers. Having declined between 2007 and 2010, passenger numbers at UK terminals have started to inch upwards and UK scheduled flights grew 1.2 per cent in the first quarter, according to the Civil Aviation Authority. The increasingly upbeat macroeconomic outlook is also good news for high street shops.
Another area of potential is WH Smith's nascent overseas operation, which is performing well. At the half-year stage in February, there were 121 overseas units, spanning the globe from Scandinavia to Australia, across airports, railway stations, hospitals and malls, while a further 30 small kiosks are being trialled in China.
| WH SMITH (SMWH) | ||||
|---|---|---|---|---|
| ORD PRICE: | 850p | MARKET VALUE: | £1.05bn | |
| TOUCH: | 850p-851p | 12-MONTH HIGH: | 859p | LOW: 570p |
| Forward dividend yield: | 4.1% | Forward PE ratio: | 11 | |
| NET ASSET VALUE: | 130p* | NET CASH: | £41m | |
| Year to 31 Aug | Turnover (£bn) | Pre-tax profit (£m) | Earnings per share (p)^ | Dividend per share (p) |
|---|---|---|---|---|
| 2010 | 1.31 | 89.0 | 45.7 | 19.4 |
| 2011 | 1.27 | 93.0 | 51.4 | 22.5 |
| 2012 | 1.24 | 102 | 63.1 | 26.9 |
| 2013** | 1.20 | 108 | 70.3 | 30.5 |
| 2014** | 1.21 | 114 | 78.6 | 34.5 |
| % change | +1 | +6 | +12 | +13 |
Normal market size: 3,000 Matched bargain trading Beta: 0.64 *Includes intangible assets of £58m or 47p a share ^Adjusted diluted EPS ** Bank of America Merrill Lynch forecasts | ||||
Margins are strong thanks to the years of efficiency gains and, by the end of this financial year, the company will have slashed £17m off its cost base. It often finds clever, if unusual, areas to save money in, such as energy-efficient tills and adding time clocks to instore chillers. It's also worth mentioning that in the UK, WH Smith has no real competitors in the travel division - where else would you go on a train station or airport terminal for a book, bottle of water and comfy neck pillow?
While the shares have admittedly risen 30 per cent year-to-date, a Bloomberg consensus forward PE ratio of just 11 represents a 34 per cent discount to the average of sector peers and is well below WH Smith's own five-year historic average forward PE ratio of 13.4. And an enterprise-value-to-operating-profit (EV/EBIT) ratio of 8.9 compares with an industry average of 12.7. True, the new chief executive has yet to prove himself, but the handover seems to have gone seamlessly so far.
