QUALIPORT
Carpetright Right Right

By Maynard Paton (TMFMayn)
December 19, 2002

Qualiport firm Carpetright (LSE: CPR) remains in great shape. Half-year numbers from the carpet retailer showed pre-tax profits increasing 8% and the dividend jumping 15%. The statement also revealed the initial performance of the company's first venture into Europe. For long-term investors prepared to ignore the siren voices of imminent economic doom, the shares look cheap at 581p. Indeed, chairman Lord Harris bought 200,000 shares at 571.5p (total cost: £1.14m) following the results announcement.

(Readers wanting background information on Carpetright may wish to click here, here, here and here)

Results

This table summarises Carpetright's half-year performance:

Six months to October            2002               2001

Turnover (£m)                 218,938            173,304
Operating Profit (£m)          24,064             21,802
Exceptional Items (£m)         (2,064)                 -
Pre-tax profit (£m)            22,115             22,301

Earnings per share (p)           23.7               20.8
Dividend per share (p)           15.0               13.0

(All figures adjusted for goodwill)

The £51m purchase of Benelux carpet chain Carpetland NV clouded the interim performance a little.

Strip out the acquisition, and UK and Ireland turnover rose 14% to £198m with like-for-like sales up 5%. Margin improvements allowed operating profits to jump 17% to £27m. A store refurbishment programme plus the introduction of wider carpets underpinned the performance. UK and Ireland market share increased 2% to 24% (the aim is 30%; nearest rival Allied Carpets has about 8%). Although the estate increased by only two stores during the period, another ten are expected to open in the next six months. Further margin enhancements are in the pipeline, too.

Europe

June's full-year results heralded the 50% purchase of Carpetland, with the balance acquired in October. During the interim period, Carpetland contributed sales of £20m and a £1.5m operating loss. Clearing out old stock, modernising the stores and other change-of-ownership disruption held back profits. The purchase also created a £2.1m exceptional charge, with another £4.2m to be expensed over the next eighteen months.

Although current trade was described as "slow" (due in part to the "difficult economic environment") in Europe, Carpetland does offer Carpetright plenty of longer-term potential. For starters, Carpetright's expertise in driving market share gains in the UK should work wonders on the continent -- Carpetland has just a 5-6% market share at the moment.

To put some of the overseas finances into perspective, gross margins at Carpetland are 51% versus 58% for Carpetright, while sales per square foot of retail space are £47 against £127. Carpetland is expected to return to profitability in the year ending April 2004.

Advantages

Just like every other retailer, Carpetight is no business 'franchise'. However, the company does have notable competitive advantages which remain firmly in place:

* Management: Executive chairman Lord Harris has been selling carpets for forty-five years. His experience involves transforming a three-store family firm into Harris Queensway, a major retail chain sold for £450m in 1988. Soon after the sale, Harris opened his first Carpetright shop and, fourteen years later, had steered his new chain to market domination. With retailing very much a management-intensive industry, Carpetright minus Lord Harris could be in trouble. For the record, Lord Harris is 59 years old.

* Price: There are many factors in deciding where to buy a carpet, with price being among them. As the largest carpet retailer in the UK, Carpetright utilises its economies of scale and buying power to attract customers looking for a wide range of 'value' offerings. Fighting on price is not the greatest of competitive weapons, but as long as Carpetright stays big, it will have a pricing advantage.

Apart from Lord Harris leaving or a rival carpet wunderkind coming onto the scene, the biggest threat to Carpetright shareholders is the domestic economy. A downturn in the property market or reduced consumer spending will undoubtedly hit earnings. For instance, the economic wobble of 1998 caused operating profits to slump 26% between 1997 and 1999. One possible sign that all is not well on the consumer spending front is Carpetright's current like-for-like UK sales running just 1.5% ahead.

Valuation and summary

Although many will speculate on the fate of the economy, there's little doubt Carpetright fundamentally remains a class act. Sure, it's not surrounded by a crocodile-filled moat, but the company's clear and robust financial performance gives it a long-term quality feel. No business generates 80%-plus incremental returns on equity without some sort of operating superiority and shareholder-orientated boardroom.

On a trailing twelve-month basis, Carpetright shares (at 581p) stand on a price to earnings ratio of 11.1 and offer a dividend yield of 6.0%. Given the expenditure on new stores over the years, it's difficult to accurately judge Carpetright's 'maintenance' capital expenditure. Assuming it's 50% higher than the depreciation charge, Carpetright shares produced free cash per share of 44.1p during the year ending October 2002. The company is thus valued on a historic free cash flow yield of 7.6%. With scope for another 90 stores in the UK and significant expansion opportunities in Europe too, the shares look cheap.

More: Carpetright 2002 Annual Results | Carpetright 2001 Interim Results | Fool Buys Carpetright | Fool Considers Carpetright

The author owns shares in Carpetright.