This British throwback deserves a second chance

For investors looking for to take a less capital-intensive punt on this theme, one FTSE 250 name might have passed under the flight radar. WH Smith (SMWH) is still associated in a lot of minds with a fading British high street, but a travel transformation over recent years means the retailer now collects around three-quarters of its revenue from sites at airports, railway stations, and hospitals. It is also making serious inroads into North America, the biggest travel retail market on the globe.

Back to the future

Back in the summer of 2021, with the shares trading at 1,755p, we thought investors should bail out. Our diagnosis of a valuation that looked too rich given weak travel recovery prospects and the potential for further pandemic restrictions proved apposite. Today, the share price is about a third lower.

Now we are in a very different world, with the shoe on the other foot. The post-pandemic travel recovery is shaping up to be quicker than anticipated – HSBC analysts recently spoke of “more assured” growth and “a continued robust outlook” – and with the prospect of fresh lockdowns seemingly unlikely, WH Smith’s valuation now offers investors the chance to buy a quality stock at a good price. While the company is still in recovery mode, in some senses, there are signs that the market is underestimating its potential.

Divisions and margins

For those unfamiliar with Smiths’ pivot from the high street to the travel hub, its latest update made clear that this business is one part growth and one mature rump. For the 20 weeks to 20 January, travel sales rose 13 per cent, while high street revenue dropped 4 per cent.

As the travel side of the business has grown (it now boasts almost 1,300 global stores), the legacy retail operation (around 500 stores) continues to drift in a state we have previously described as “managed decline”. On the latest evidence, we see no reason to change that view. The high street's contribution has fallen from over 60 per cent of sales to just a quarter in a decade, and profits are middling.

While the latest trading figures highlight the discrepancy in fortunes between the divisions, they also flag that WH Smith’s key growth engine has made material progress in its post-pandemic recovery. In the year to August, the travel arm’s operating profit of £166m was 42 per cent up on 2019. On the high street, where outlet numbers have thinned, a profit of £43mn was £17mn under the pre-pandemic baseline.

On the plus side, high-street profitability is being supported by cost savings. The company is slicing off an average of 50 per cent on rent at lease renewal, which softens the hit to footfall and supports the case for taking the cash and margin benefits while it can. The average lease length is under two years and around 480 leases are up for renewal in the next three years, giving flexibility for future wind-downs.

Management points to “space growth, increasing ATV [average transaction value] and spend per passenger... [and] the growth in passenger numbers and customers” as key drivers for travel profit growth. It is putting in the investment to maximise these tailwinds, with capex set to be around £140mn this year. The expansion of product ranges across categories like health and beauty is something to watch, too.

The margin recovery is ongoing, with analysts forecasting the 2024 operating margin to come within 70-basis points of 2019 profitability. While the North American margin is now ahead over five years, the margin in the group’s biggest division, UK travel, is behind its pre-pandemic comparator. 

International growth

WH Smith’s expansion in the US is a key plank of the bull case, given the size of the addressable market. To date, the company’s penetration of the US has been driven by acquisitions, first via the purchase of digital accessories retailer InMotion for $198mn (£156mn) in 2018, followed by travel retailer Marshall Retail Group (MRG) for $400mn in late 2019. The MRG airport business now contributes around half of the company’s total revenue in North America, though there is also a division focused on Las Vegas resorts.

The company had around 330 stores in the US at the latest count, across airports, resorts, and rail. This represents growth of a fifth against 2020, with 50 more US sites scheduled to open this year, which explains why Investec thinks a tripling of US profits in the medium-term is achievable.

WH Smith says it has around a 13 per cent market share in North America, and is aiming to get this up to 20 per cent in the next five years, which would mean several hundred new stores are on the table. Its proposition is clearly proving attractive when it comes to the market share, as evidenced by its move into 85 per cent of the retail space at Kansas City airport – to cite just one example.

While like-for-like North America sales were flat in the period to January, this shouldn’t be cause for alarm. Though non-US air passenger numbers were still recovering, InMotion faced fewer electricals product launches, and the Las Vegas business was up against tough comparatives, regional sales still rose 7 per cent. What’s more, there are significant opportunities to consider elsewhere: this year, 40 stores are earmarked for opening in continental Europe, while WH Smith already has more than 200 locations across the Middle East and India and Asia Pacific.

Big debts, but a discount rating

Given the growth push, and the enduring effects of Covid, net debt has remained stubbornly high. This was £895mn last summer, up from £837mn in 2021, although three-fifths of the balance is lease liabilities, with the balance in a revolving credit facility and convertible bonds that mature in 2026. Management forecasts, encouragingly, that leverage will fall from 1.4 times to 0.75-1.25 times this financial year.

A recent de-rating helps the bull case. The shares trade at 13 times’ forward consensus earnings, well below the (admittedly skewed) five-year average of 38 times. This looks cheap for a company posting double-digit growth and with big, if manageable plans for international expansion.

This year, analysts expect revenue to outstrip pre-pandemic levels by 40 per cent, and for headline pre-tax profits to surpass the 2019 watermark. With plenty of room to grow market share, we think things are set to head in the right direction. City brokers, according to FactSet, have a mean target price of around 1,730p, back to where we were in 2021. This time, such a price appears much more deserved.