Buy into WH Smith's global ambition

With a traditional focus on many products that have faced huge challenges from the internet, such as magazines, newspapers and books, WH Smith's high-street business has focused on cutting costs and selling its more promising wares, such as stationery. At the same time the group has looked to its higher-margin travel business – stores in airports, motorway services and train stations, among other places – for growth.

The change has happened quickly. The travel division generated more sales that the high-street stores for the first time in 2017 and last year accounted for 53 per cent of revenue and 63 per cent of trading profit. Within the travel division, the group has been improving profitability through its product mix, with a 120 basis point improvement in the gross margin in 2018 following on from 100 basis points in 2017.

It plans to keep growing like-for-like revenue through a focus on execution and service. It is also developing new store layouts such as the 'large airport' format, which management says can deliver increased customer spend. It is currently testing this format in London’s Gatwick North, Gatwick South and Heathrow Terminal 3. The other plank of the growth strategy is expanding the store network internationally. Last year, around a third of travel stores were international, with about half of those operated as franchises and another tenth as joint ventures. Overall, about a fifth of travel revenue was from overseas as was about a tenth of travel profit. But the scale of the international travel business is about to get a major boost.

At the end of November, WH Smith completed the $198m (£155m) acquisition of US digital-accessories travel retailer InMotion. InMotion has doubled the size of WH Smith’s international travel business, adding 114 stores across 43 US airports and should boost earnings per share this year. While the price paid for InMotion at 10 times cash profits is not cheap, the business boasts very impressive top- and bottom-line annual growth of around 20 per cent. It also gives WH Smith the opportunity to use InMotion's relationships with landlords to export its store formats across the Atlantic while introducing the rest of the world to electronics-focused InMotion stores. True, worries about the health of the global economy are relevant given the reliance of the travel business on passenger numbers, but currently there is a lot to be positive about.

While the travel business should continue to grow, the story of the high street business continues to be one of managed decline. However, WH Smith has managed the decline very well. Savings of £12m were made last year and a further £9m are earmarked for the current year. Lease lengths are only 4.5 years, leaving good flexibility to close unprofitable stores – store numbers dropped by four last year to 607, with some exceptional costs associated with restructuring. What's more, the company has been able to continue to push gross margins up by changing the product mix.

WH Smith can be thought of as two companies in one, with the travel and high-street divisions run by separate management teams with different strategies, operating models and cost structures. However, the high-street business’s management is similarly focused on using the product mix to drive margin growth, as well as a “forensic focus” on space. Stationery is a vital part of the high street business, responsible for roughly half of the division’s sales. The group is experimenting with low-cost initiatives and dedicated pen shops to capitalise on this.

A key appeal for investors is cash generation. WH Smith generated free cash flow of £96m last year, down slightly from the previous year due to increased capital expenditure and working capital. Management is committed to returning money to shareholders through dividends and share buybacks. Since 2007 it has returned £1bn. The balance sheet is healthy but should be seen in context of the group's lease commitments (a liability worth roughly £1.5bn if valued at seven times last year's rent bill), which new accounting rules will require to be reported on the balance sheet from next year.