QUALIPORT
Phew! Carpetright Defies The Doomsters

By Maynard Paton (TMFMayn)
July 3, 2003

Phew! Tuesday's preliminary results from Qualiport member Carpetright (LSE: CPR) did not contain any bad news. Following the carpet retailer's April update, which revealed a slowdown in fourth-quarter sales, a further admission of meagre sales could well have been forthcoming. In the end, Carpetright defied all the doomsters by revealing a top-line revival.

The results re-emphasised the company's competitive advantage, that of keeping prices keen and costs lean. In just 15 years, the philosophy has taken the group from a single store in Essex to UK domination and shows no sign of waning. Read more.

(More Qualiport articles on Carpetright can be found here, here, here and here).

Five-year record

The table below shows Carpetright's five-year financial performance:

Year to April              1999     2000     2001     2002     2003

Turnover (£m)             277.7    304.8    322.9    361.5    436.8
Operating Profit* (£m)     23.2     36.9     44.7     52.0     55.0
Exceptional Items (£m)        -        -        -        -     (5.4)
Pre-tax Profit* (£m)       23.5     36.6     45.6     52.5     51.6

Earnings per share*(p)     22.8     33.3     42.0     48.4     56.2
Dividend per share (p)     22.3     23.5     27.0     33.0     37.0

(* Before goodwill and exceptional items)

Group turnover jumped 21% to £437m in the year ending May 3rd 2003. Opening another four stores (taking the estate to 351), a like-for-like (LFL) sales improvement of 2.6% and an extra trading week helped UK & Republic of Ireland sales improve 7% to £369m. Margins increased again, from 14.5% to 15.0%, which helped boost domestic operating profits by 11% to £58m.

The £34m purchase of Carpetland NV, the leading carpet retailer in Holland and Belgium, generated an extra £50m of revenues. A complete overhaul of this business caused it to register a £3m operating loss and a £5m exceptional charge (the first in Carpetright's ten-year listed history).

Though European sales were a little below expectations, the subsidiary has obvious potential. With the restructure now complete, the target is to double its 6% market share over the next three years. Sales per store on the continent were about £650,000 during the year, compared to £1.1m in the UK. There is no sign yet of this venture being an overseas disaster.

Cash Flow

The results presented no worries on the cash flow front:

Year to April                1999     2000     2001     2002     2003

Operating Profit (£m)        23.2     36.9     44.7     52.0     55.0 

Net change in
  working capital (£m)        5.6      2.7      6.0     (5.4)     7.7 

Depreciation (£m)             7.5      7.5      8.1      9.8     12.9 
Net capital expenditure (£m) (9.5)    (4.1)   (22.5)   (22.1)   (11.0) 

The year saw a welcome inflow of working capital cash, which reversed last year's out-of-character outflow. Stock turn also reduced, albeit from 71 days to 70, to halt a slightly worrying trend noted in last year's full-year review. In addition, net capital expenditure this time around was under the depreciation charge. However, over the past five years, capex has exceeded depreciation by around 50% on average.

The Carpetland purchase left Carpetright with £33m of net debt at the year-end. Gross interest cover during the year came to an extremely comfortable 27 times. The strong cash flow performance allowed the dividend to be raised 12% to 37p per share. Commendably, Carpetright spent £9m on a share buyback just before the year-end and another £3m immediately after this week's results.

One superb feature of the accounts is Carpetright's incremental return on equity. During the five years to April 2003, Carpetright's adjusted equity base increased from £41.1m to £61.1m. Over the same time, earnings rose from £20.7m to £42.2m. The resulting incremental return on equity is thus an eye-popping 107% (£42.2m - £20.7m)/£61.1m - £41.1m)). The ten-year figure comes to an astonishing 77%.

One item missing from the results statement was a note on FRS 17 and the company pension scheme. However, Carpetright's pension deficit amounted to just £1m last year, so shareholders should not be overly concerned.

Valuation and summary

These results were better than expected. Carpetright's admission in April that fourth-quarter UK sales were below expectations had many -- including the Qualiport -- anticipating further lacklustre news. Yet Carpetright appears to have bounced back. During the relatively quiet months of May and June, LFL sales were running 2.2% ahead in the UK.

Still, shareholders shouldn't get too complacent. The company is reliant on property market activity (when people move home, they replace the carpet) and the likes of Countrywide Assured (LSE: CWA) and Bradford & Bingley (LSE: BB.) have blamed a housing market slowdown for recent profit alerts. A contraction in consumer spending will also hurt 'big ticket' firms like Carpetright.

However, with a 25% market share in the UK, Carpetright is by miles the country's largest carpet merchant. Opportunities at home, through extra outlets, link-ups with department stores and moves to sell laminate flooring, are still for the taking. By no means an operational franchise, the 'moat' shortfall is partly made up by Carpetright being a simple company with a straightforward strategy, proven shareholder-orientated management and crystal clear accounts.

At 650p, Carpetright shares trade on a price to earnings ratio of 11.6 and offer a dividend yield of 5.7% based on the latest results. Assuming:

* UK & Republic of Ireland profits stay flat;
* The European operation breaks even;
* Maintenance capital expenditure is 1.5 times depreciation;
* Net interest payments on £33m net debt come to £2.4m, and;
* Corporation tax is 30%.

... then 47.1p per share of free cash can be expected in the current year. Demanding a free cash flow yield of 7.5% requires a 627p entry price.

The author owns shares in Carpetright.

More: Last year's Interim Results | Last year's Annual Results | Fool Buys Carpetright