QUALIPORT
Carpetright: Piling On The Profits

By Maynard Paton (TMFMayn)
December 13, 2001

Carburton Street, London -- Qualiport member Carpetright (LSE: CPR) published its interim results on Tuesday. Given the generally subdued economic climate, the carpet retailer put in a very impressive six-month performance. Although there were one or two niggles within the statement, this portfolio remains a keen shareholder. What's more, Carpetright shares still look reasonably cheap, too.

Interim numbers

Here are Carpetright's latest numbers:

                         Six months to   Six months to     Change
                           27/10/01        28/10/01         (%)

Turnover (£m)                173.3           153.4         +13.0
Operating Profit (£m)         21.8            19.1         +14.4
Pre-tax Profit (£m)           22.3            19.0         +17.2

Earnings per share (p)        20.8            17.7         +17.5
Dividend per share (p)        13.0            11.0         +18.2

The 13% sales improvement was underpinned by 18 new stores opening since October 2000, and like-for-like (LFL) sales growth running at 8.8%. The LFL performance was very notable. Not only did LFL sales grow at a not-to-be-sniffed-at 6.4% in the comparable period of the year before, but the latest interim performance has continued into Carpetright's second half. LFL sales growth is presently running 9% ahead.

Furthermore, the LFL accomplishment compares quite well to other household furniture retailers. Although there's no other quoted carpet merchant, both DFS Furniture (LSE: DFS) and ScS Upholstery (LSE: SUY) recently reported LFL sales growth of just 3%.

On a rolling twelve month basis, there was evidence of greater efficiencies and economies of scale. Gross margins increased from 55.7% to 57.2% while operating margins improved from 12.9% to 13.8%. The company's 15% margin target still looks achievable over the next two years or so.

Carpetright also gave some pleasing news on store openings. Following a review of the company's retail formats and locations, the total number of outlets increased from 321 to just 325 during the year to April 2001.

However, in the latest six-month period, the estate increased to 338 sites. Furthermore, there are plans to open another 30 stores between now and next April. Carpetright's reported store target is around 450, a total that should allow the company to meet its 30% market share goal (Carpetright presently has around a 20% market share).

Mobile service

But there were two niggles with the latest statement.

Firstly, Carpetright continues to be tight-lipped on its mobile sales service. Previous reports had suggested the company could generate revenues of anything up to £200m in this area in future. Apart from highlighting 27 vans were in presently operation, this week's statement simply remarked:

"The alignment of the management of stores and Harris Carpets at Home has enabled a strong service offering to direct retail and insurance business undertaken by the vans, and the efficient utilisation of estimators within the store environment."

Secondly, there was Carpetright's operating cash flow.

                         Six months to  Six months to    Year to
                           27/10/01       28/10/01      28/04/01

Operating Profit (£m)         21.8           19.1          44.7
Depreciation (£m)              4.9            3.8           8.2
Decrease in stocks (£m)        1.9           (0.1)         (6.2)
Increase in debtors (£m)      (5.7)          (2.9)         (0.7)
Decrease in creditors (£m)    (0.6)           9.5          12.9

Operating cash flow (£m)      22.3           29.3          58.8

I've written in the past about the great working capital characteristics of Carpetright. After years of consistently spitting out net cash in this area, it comes as some surprise to see net cash being absorbed into working capital. One possible explanation would be Carpetright's increased dealings with insurance companies, who are unlikely to pay upfront for their clients' carpets. But it's reassuring to note that the high stock levels seen at the full-year stage have been reduced slightly.

Valuation

However, given the proven financial and management record at Carpetright, these are minor complaints. The company continues to be a simple, attractive business for long-term shareholders. And one astonishing feature of Carpetright remains the minimal capital tied up in the company. During the twelve months to October 2001, earnings of £34.0m were generated from an average equity base of £43.2m. The return on average equity is thus a stunning 79%.

In terms of valuation, I estimate Carpetright's trailing free cash flow to be 40.9p per share. If we assume the group's free cash flow expands at just 7% over the next twelve months, at 596p, Carpetright shares stand on a forward free cash flow yield of 7.3%. Given that nearly two-thirds of profits are distributed as a dependable dividend, the present price is bordering on the 'very attractive' level.

Risks

But the risks of holding Carpetright shares remain the same:

* Management: Selling commodity-ish goods with price as your main weapon requires solid management skills. While not putting a foot wrong since their 1993 flotation, should management suddenly go off the boil, shareholders will be in trouble.

* Competition: The retail sector is notoriously competitive and fickle. Barriers to entry are low and there's little customer loyalty for the price-conscious retailer. But being one of just two major industry players, Carpetright's competitive advantages are its economies of scale and purchasing power.

* Recession: Carpets sales are very sensitive to the general health of the economy and property market.

Of the three points, the threat of recession is the least worrisome. For starters, it's something the company can't do anything about (not that any investor can accurately predict the timing and impact of a recession, anyway). Furthermore, any economic downturn should prove beneficial to Carpetright in the long run, as less effective rivals go to the wall. Of the other two points, the latest results showed no sign of management or competitive woes.

More: Fool Buys Carpetright | Carpetright Bargain | Carpetright discussion board

The author owns shares in Carpetright