Argos and Homebase owner Home Retail Group (LSE: HOME) surprised investors this morning by announcing plans to shut 25% of Homebase stores alongside its first-half results.
The results themselves weren’t bad — like-for-like sales were up 2.9% at Argos and 4.1% at Homebase, and adjusted pre-tax profits were up 13% — but Home Retail’s decision to shut 25% of Homebase stores by the end of 2018 suggests that there are underlying problems at the DIY chain.
Slim profits
In today’s announcement, Home Retail said that “low sales densities” were resulting in a “challenged financial model” for Homebase. Translated, this means that the company’s sales are spread too thinly across its stores, resulting in poor profitability.
This becomes obvious when you compare Homebase’s profits to those of B&Q and Screwfix, which are owned by Kingfisher (LSE: KGF). Homebase reported an adjusted operating margin of 3.3% for the first half of this year, less than half the 6.9% operating margin generated by B&Q and Screwfix over the same period.
Heading for trouble?
Home Retail may manage to solve its Homebase problems, but I’m also concerned about Argos, which accounts for 66% of Home Retail’s sales. Argos reported an operating margin of just 0.7% for the first half of this year, and that’s an improvement on the same period last year!
Home Retail Group’s overall operating margin is only 1.1%, and for me, that’s very risky, and could easily threaten the company’s below-average 2.2% dividend yield.
Better buys elsewhere
Kingfisher’s overall operating margin during the first half of this year was 6.4%. With net cash in the bank, a 4% prospective yield, and a P/E of 13, the downside risk seem limited to me, and I rate Kingfisher shares as a buy.
Similarly, home furnishing specialist Dunelm Group (LSE: DNLM) appears much better able to cater for UK shoppers’ needs than Home Retail Group. Dunelm reported an impressive 15% operating margin last year.
Dunelm has grown its dividend by an average of 27% per year since 2009, and currently offers a prospective yield of 2.6%. Although the firm’s shares trade on a more ambitious forecast P/E of 17, I feel that this is less risky than Home Retail Group, whose shares trade on a forecast P/E of 14, despite Home Retail’s borderline profitability.
For me, Home Retail is a share to avoid, especially when so many better options are available.