Nick Bubb's verdict: WHSmith - The margin was the message

Although the common cry has been that WHSmith has only managed to offset declining LFL sales by slashing costs, Kate Swann’s real achievement over the past nine years has been engineering a huge rise in the company’s gross margin.

If I’d had a £5 money-off coupon for every time somebody said that WHSmith will never succeed with LFL sales always falling, then I’d have a lot of vouchers. And the story hasn’t just been about slashing costs either, although that has been part of the approach to maximising the profitability of the high street chain - and WHSmith has in fact found even more cost savings to announce today.

Swann’s key legacy is a dramatic increase in the gross margin of the business, thanks to a clever re-engineering of the sales mix. When she took over as chief executive in November 2003 of what used to be one of the worst managed retailers in the country, the WHSmith gross margin used to be about 39%. That gross margin is now well over 53%, so in the space of nine years it has moved up by over 1400bps, a fairly staggering achievement. And WHSmith is guiding to a further 150bps increase in the current financial year, so the gross margin rise still has legs.

Of course, the main driver of the gross margin increase has been the big move away from selling low-margin ‘entertainment’ categories like CDs, DVDs and video games (which were a big part, around 25%, of the sales mix back in 2003), and the switch towards higher margin products like stationery, books and impulse buys.

That has been bad for top-line sales, but good for bottom-line profit. However, with the entertainment mix shift now all but done, the focus is moving on to intra-category mix management, promotional mix management and supply chain work, and the WHSmith team is highly confident that there is more potential upside to exploit.

In passing, if you want to know the difference in profitability between a ‘3 for 2’ deal and a ‘Buy One Get One Free’ promotion, then Swann is your woman, because she is highly numerate and has such detail at her fingertips.

Since 2003 the sales of the WHSmith high street division have fallen by as much as 33%, to £781m, yet operating profits have been largely maintained, which is obviously more than can be said of such high street stalwarts as Woolworths, HMV and Game Group. It may not be pretty retailing, as you can read elsewhere in John Ryan’s column, but it has been highly effective retailing, and WHSmith has also shown that it can grow new high street ormats, such as Funky Pigeon.

But Swann’s other great legacy is the growth of the so-called ‘travel division’, which now encompasses hospitals, work-place stores and motorway service stations, as well as airports and railway stations. Back in 2003 the group was dominated by its high street division and the travel division accounted for less than 20% of total sales, but next year it will account for over 40% and it is highly profitable.

The travel division overtook the high street division in absolute profits some time ago and its £63m contribution to EBIT in the last financial year compares with just £19m nine years ago, despite the recent and unwelcome fall in UK airport passenger traffic. In this division too there is format evolution going on, with the classy looking London News stores at Gatwick a case in point.

Increasingly, however, the future of the travel division lies overseas. WHSmith now has more than 100 overseas locations, having made good progress in India, Australia and the Middle East. Today’s announcement of 21 new units includes five units in Amman airport in Jordan. But Swann is known to be not overly fond of travelling, which is perhaps why she feels the time is right to move on to a new UK challenge. She will leave WHSmith in great shape in mid-2013, with her legacy intact. Given her impressive record of shareholder value creation, many shareholders will be understandably eager to follow her in her next venture.