QUALIPORT
The Market's Best Mid-Cap Yield

By Maynard Paton (TMFMayn)
February 5, 2004

Qualiport member DFS Furniture (LSE: DFS) sports the best dividend yield in the FTSE 250 -- some 6.6% in fact. Save for a few utilities and crisis play Jarvis (LSE: JRVS), where thin dividend covers and/or falling profits put the payouts in question, the income on offer from the furniture retailer is difficult to beat. Compared to the market as a whole (a 3.23% dividend yield) and the income from government bonds (4.90% from ten-year gilts), DFS shares look very cheap.

Cheap shares, though, are rarely cheap without reason. On Tuesday, a trading statement from DFS revealed a contraction in underlying sales and an admission that first-half profits were running below levels seen last year. DFS noted: "Our sector is feeling the effects of intense competition from both new entrants and established players, with increasingly aggressive promotional activity." Though the following sales figures from rivals include beds, kitchens and a wide variety of furniture, their performances suggest DFS is losing ground:

Company	Period	Like-for-like sales (%)
DFS	9 weeks to 31 Jan	-3.2
	26 weeks to 31 Jan	-2.2
Courts (LSE: CRTO)	7 weeks to 18 Jan	+31
ScS Upholstery (LSE: SUY)	9 weeks to 3 Dec	+5
MFI Furniture (LSE: MFI)	19 weeks to 1 Nov	+0
Homestyle (LSE: HME)	7 weeks to 17 Jan	+1

But as DFS boss Lord Kirkham reminded the market this week: "We undoubtedly have the best product range, visual merchandising and people in our sector, and this is reflected in our performance ratios and solid finances." Shareholders should therefore not forget DFS is a quality outfit: it remains the market leader in its upholstery niche, the experienced boardroom has coped successfully with difficult times before and the accounts are still some of the best around. Read more | more.

Given the yield attractions, it's worth remembering DFS' reputation for reliable payouts and its strong balance sheet. The company floated in 1993 and has provided annual increases to its dividend ever since (up from 7.2p per share to 24p). Importantly, when the firm lost its way during 1998/9 and profits slumped by a third, dividend progress was still made.

What's more, DFS has paid five special dividends as a listed company, totalling some 64.1p per share. The dividend was covered 1.5 times during fiscal 2003 while net cash in the bank at the end of July 2003 amounted to £32m, or 30p per share. All in all, there's no reason to expect DFS dividend difficulties anytime soon.

So the main performance issue for DFS investors is something they can do little about -- the economy. Lord Kirkham again: "The outlook for UK consumer spending also appears uncertain in the light of growing concern about debt levels and the likelihood of a rise in interest rates."

Sales of discretionary 'big ticket' items (the average DFS sofa sells for £1,500) will be the first to evaporate in a consumer spend downturn, with weak trading at conservatory group Ultraframe (LSE UTF) adding to the evidence of home improvement belt-tightening. Any furniture shake out, however, will almost certainly see DFS emerge in a relatively stronger position. And it's fair to say the 6.6% yield (based on a 364p share price and the 2003 payout) is already factoring in some sort of sector bloodbath.

Carpet

From sofas to carpet. Fellow portfolio share Carpetright (LSE: CPR) also issued a trading statement on Tuesday, but with contrasting sales news. Britain's leading carpet retailer confirmed like-for-like sales had improved by 4.6% during November, December and January. Sadly, Carpetright's shares do not offer the same obvious value as DFS. With the shares at 882p, the trailing dividend yield is 4.4% and free cash flow yield is 6.1%.

But given the common market-leading home furnishing theme, what's behind the sales divergence with DFS?

Firstly, there are different competitive structures within the two sub-sectors. Sofas provide much more scope for competing on design and style, so allowing much more in the way of industry rivalry and innovation. Carpet, on the other hand, is carpet and is very much a volume/price game. Maintaining economies of scale in floorcoverings -- the largest being held by Carpetright -- is thus key to fending off opponents.

Then there's the price differential between a new carpet and sofa. Carpetright noted in its Dcember interim results: "The roll stock offer, which has seen significant improvement in range, styling and product development has proven increasingly popular at the value end of the market where an average room will cost less than £95 to carpet. We believe this quality, affordable product, which still makes up the majority of our sales, will continue to appeal and grow sales in the future."

If home-improving consumers are currently exercising some prudence then, £95 sales of Carpetright carpet won't dry up as quickly as £1,500 DFS sofas. As the Financial Times put it on Wednesday: "Carpet buyers may well compromise on re-flooring one room when they cannot afford to do two, but consumers whose caution makes them reluctant to buy a sofa are unlikely to settle for a chair."

More: DFS: Dividend Fortune Share | The Pros And Cons Of Carpetright

The author owns shares in Carpetright and DFS Furniture.