Time to take profits on this quality mid-cap?

Dragged down by its high street estate, Paul Summers thinks it might be time to bail on the world’s oldest national retail chain.

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As a company, there’s a lot to like about bookseller, stationer and newsagent WH Smith (LSE: SMWH): a history of great returns on capital, decent free cash flow, a well-covered dividend and a travel division (in stations and airports) that rarely disappoints. Its shares have climbed almost 250% in the last five years.

So, what’s my reasoning for believing that now might be a good time for holders to take at least some profit off the table? Read on.

Dragged down

Today’s trading update for the 15 weeks from the start of March to last Saturday was something of a mixed bag.

Smith’s travel business continues to perform well, with total sales rising 8% and like-for-like sales up 5%. This was partly explained by the continued increase in passenger numbers as well as a currency boost from its international operations. 

Elsewhere, the numbers aren’t so great. Total and like-for-like sales from its high street stores both fell 4%, underlining how it’s not just established clothing retailers that are being hurt by the explosion in online retailing and increased competition. These disappointing figures put a drag on the company’s overall performance in Q3 with group sales up 2% and like-for-like sales flat.

Today’s update effectively summarises why I’m bearish on WH Smith. While its travel units benefit from a captive audience who have neither the time nor inclination to shop around for the best deal on the latest Man Booker Prize winner, the same can’t be said for its high street estate. I’m simply not sold on the idea that shoppers will someday revert to buying items here when they can get these cheaper online. Will magazines and birthday cards be enough to sustain profits over the long term? I’m not convinced.

With wage growth slowing and inflation at a four-year high, I suspect things could get even worse for this side of the business, which makes me question why management continues to throw significant amounts of money at it.  

Time will tell whether the tightening of purses will be sufficient to impact on sentiment towards the stock but, with a price-to-earnings (P/E) ratio of 17 for 2017, I think the positives are priced in.

Better growth prospects

If, like me, you believe that WH Smith’s shares may begin to lose momentum, a worthy alternative could be leading food and drink outlet operator SSP Group (LSE: SSPG). Since I last looked at the company, the shares have done well, climbing 19% to just under 485p. 

Back in May, the company revealed a solid set of interim results to the market. In the six months to the end of March, revenue climbed 8.1% to almost £1.1bn with like-for-like sales rising 2.9%. Encouragingly, underlying operating profit came in at £42.8m — a 25% rise at constant currency. 

With its presence in North America and the Asia Pacific region (particularly India) growing and a “robust pipeline” of new contracts in place, I think the £2.3bn cap has a bright future. The recent 28% hike to the interim payout certainly gives some indication of just how confident management feels about the company’s prospects.

Right now, a predicted 21% rise in earnings per share in 2017 leaves SSP’s shares trading on a fairly steep PE of 26. That’s a high valuation but one that I feel can still be justified. One to buy on the dips perhaps?

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Paul Summers has no position in any shares mentioned. The Motley Fool UK owns shares of SSP Group. The Motley Fool UK has recommended WH Smith. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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