Carpetright is going from strength to strength. Shareholders should jump with joy.
So, that was the retailing slump. Here and gone in the blink of an eye. It was easy to miss.
A trading update from Tesco
(LSE: TSCO)
on 5th December suggests all is well in shopping centres across the land.
As for Carpetright
(LSE: CPR)
which released its interim results today, the "retail slump" occurred in the first quarter of its financial year with like-for like-sales down 0.3%. Today they were reported as being up 0.9%.
The results also report that operating profit is up 10.8% to £28.6 million on sales of £228.4 million, up 6%. And the dividend is being hiked by 5.3%. Gross margin is up 2.3 points to 61.9% and operating margin is up to 12.6% from 11.4%.
And this growth is cash generative. Net debt fell to £22.9 million compared to £49.7 million in the same period last year.
So, shareholders should be jumping with glee on their wall-to-wall thick pile. But are there any nasty pins hiding that could bring their joy to an abrupt and painful end?
Firstly, let's deal with the housing downturn theory. This assumes that during a housing downturn, Carpetright will suffer, because when the public don't buy houses, they don't buy floor coverings either. The problem with this is that it assumes that a severe housing downturn will actually occur. It also assumes a correlation that is backed up by no hard evidence whatsoever.
A more important point is that Carpetright shares are just too expensive at the moment.The historical price-earnings ratio is 22 and it is 19 for 2007. In addition, the PEG ratio is 1.7.
Also, although gearing has fallen, at 43% it is still too high. In addition to this, like most retailers, Carpetright is "operationally geared" because it leases a large amount of property. Carpetright's 2006 Annual Report states that its lease obligations are around £63 million for one year. If we capitalise this using a suitable discount rate, say 6%, we get £703 million. This means the 'notional' gearing of the company is 136%.
This underlines the vulnerability of profits if sales should start to slip.
The other issue is dividend cover. Of 28p per share earnings, 20p is being paid out as a dividend. If profits decline a dividend cut may be likely.
One final vulnerability is Lord Harris, the chairman and the brains and energy behind Carpetright. He is 64 years old. What happens when he finally retires? For that matter, when will he decide to retire?
Carpetright is a great company lead by a savvy businessman, but at the current price, I'll steer clear.
