QUALIPORT
Cash In The Sofa

By Maynard Paton (TMFMayn)
April 15, 2004

There's a lot going on at Qualiport member DFS Furniture (LSE: DFS). A warning earlier in the year forewarned of falling profits, which were today confirmed in the group's half-year results. Meanwhile, executive chairman and company founder Graham Kirkham continues to ponder a rather mean bid. But with plenty of cash in the bank and some hidden assets, current shareholders may yet extract a few more pennies from the back of this particular sofa retailer.

(Readers unfamiliar with DFS may wish to read about Kirkham's derisory 415p bid, the market's best mid-cap yield and the Qualiport's dividend fortune share.)

Results

The six-month figures are shown below:

26 weeks to c31 January	2004	2003
Turnover (£m)	249.4	241.9
Operating profit (£m)	23.9	25.9
Exceptional items (£m)	5.7	-
Pre-tax profit (£m)	30.2	26.1
Earnings per share (p)	15.4	16.8
Dividend per share (p)	7.0	7.0

Kirkham explained the cause of the earnings shortfall: 'The disappointing result for this half year reflects the growing intensity of competition in our market place, which I have highlighted in previous reports. The entry to the home furnishings market of many highly professional new retailers, with strong pedigrees in other sectors, has stimulated much aggressive promotional activity...'

The performance will soon put the group's store rollout plan on hold: 'Following this decade of continual expansion and the growing competition in the market place for sites, staff and sales, we believe that it would be prudent to allow a period of consolidation once the current pipeline of developments is completed... Our experience of cannibalisation following recent openings has been more severe than we expected, and this must limit the potential for further expansion of our current upholstery format.'

Following the lack of progress in the first half, DFS anticipates pre-tax profits for the full year to be around £51m and at the lower end of City expectations.

Takeover talk

The bid situation at DFS creates something of a dilemma for shareholders. To recap, Kirkham indicated last month he was considering buying DFS for 415p a share, so his results spiel has to be read with that in mind.

You see, Kirkham could very well be talking the company's prospects down in the hope of buying it on the cheap. Alternatively, Kirkham's first-half account may be quite genuine, so making his possible offer an escape route before profits fall further and the share price (if a formal bid fails to materialise) takes a hammering.

Anyway, today's accompanying offer update statement revealed no further progress, with the company's non-executive directors not yet able to agree to a deal that could be recommended to shareholders. City rumours, though, suggest a 430p-440p per share bid could be in the offing.

Whatever, the Qualiport's overall conclusion remains the same as before. If such a successful businessman as Kirkham wants to buy at 415p (or 430p-440p), it's worth holding on to the shares. With DFS shares at 435p, upside is most likely to be had, not least because the offers touted are not particularly generous.

Value factors

Today's £51m pre-tax profit forecast equates to earnings per share of 32.0p. At the current 435p share price then, the forward price to earnings ratio is 13.6. Also, if the current year's final dividend is maintained (at 17p), the prospective yield comes to 5.5%. During the twelve months ending January 2004, DFS produced estimated free cash of 27.8p per share. With net free cash of £39.6m (37p per share) in the bank, the historic free cash flow yield comes to 7.0%. None of these measures seem excessive.

There are three other value factors to consider, too:

1. Hidden assets:  Today's six-month figures were bolstered by the £10m disposal of the company's store in New Malden, Surrey. The sale generated an accounting profit of £6m, which suggests the market value of some (if not most) of DFS' stores is greater than that stated in the accounts. Indeed, DFS' 2003 annual report confirms the most recent valuation of the group's land and buildings took place in 1993. The book value of freehold properties at July 2003 was £47m.

For the record, the New Malden site was purchased in 1995, at which time DFS operated 30 stores. The present store count is 65.

2. Store opening costs: With the rollout programme about to grind to a halt, much less will be spent on store pre-opening expenses and promotional launches. DFS writes off all such expenditure as incurred, which for the past two years has run at £4m per annum -- not an insignificant amount when operating profits are £54m.

3. Primback windfall: DFS is embroiled in a protracted legal wrangle about VAT payments. The so-called 'Primback' dispute involves £57m (52p per share) and shareholders may in future be entitled to none, some or all of the money. But it's anyone's guess as to when a final ruling will emerge and which way it will go.

Show us the money

Finally, when can shareholders expect further bid developments? Two other high street management buyout situations provide some insight.

Dave Whelan, boss of JJB Sports (LSE: JJB), admitted he was considering buying the sports retailer in March 2003. His indicative offer was rejected three months later.

New Look (LSE: NEW) founder Tom Singh confirmed he was reviewing his 'strategic options' with regard to his company shareholding in July 2003. One month later, he revealed he could make an offer for the clothing group. An indicative proposal then arrived in September, a revised proposal came in October and a formal bid was finally presented in February this year.

Though Kirkham, Whelan and Singh know every inch of their respective company accounts, it appears 'due diligence' and the associated paperwork can take some months. DFS shareholders probably shouldn't expect to hear of further buyout developments until June at the earliest.

Qualiport publication

Please note that this is the final Thursday appearance of the Qualiport and portfolio articles will now be published weekly.

Where next? Kirkham's Derisory 415p Bid | The Market's Best Mid-Cap Yield | Dividend Fortune Share

The author owns shares in DFS Furniture.