Nick Bubb's Verdict: Sales bad, profits good at WHSmith... again

Bearish hedge funds have been targeting several UK retailers in recent weeks, expecting their shares to go down after disappointing trading at Christmas. But there was never any chance that those attempting to short WHSmith would win their bet, because chief executive Kate Swann always delivers the goods

WHSmith is unusual in the retail world, as it has not had to make a success of online and multi-channel retailing to prop up its top-line and generate its formidable profits, earnings and dividend growth record, as its online presence is limited. But given the well-documented boom in online retailing this Christmas, and the recent collapse of HMV and Blockbuster, the bears of WHSmith must have hoped that this time round it might be different and that the management wouldn’t be able to juggle sales and margins so easily.

To be fair, WHSmith were hoping to do a bit better than the -5% LFL sales over the key last 10 weeks of trading, so the bears were right to think there could be disappointment with the top-line in the business at Christmas, with high street footfall under pressure and with passenger traffic through the lucrative airport stores continuing to be subdued. And other things being equal WHSmith could have disappointed on the bottom-line, given the potential impact of negative operational gearing.

However, “the margin is the message” has been Kate Swann’s mantra in her time at WHSmith, and the impressive 160 basis point improvement in the overall gross margin over the last 20 weeks must take the cumulative increase in the gross margin to an astonishing 1500 basis points or so since she became chief executive.

The key driver of that gross margin increase has, of course, been the shrewd move away from low-margin entertainment sales into high-margin stationery and impulse sales, but though that massive sales mix shift is largely complete, WHSmith are also generating big margin gains from promotional management and supply chain work. WHSmith is a highly promotional business, but it knows when it makes no sense to sell things for no profit and it clearly backed away from some of the aggressive discounting in the book market at Christmas.

The other big focus in the business is on cost control and WHSmith has more flexibility than other retailers, as its travel division enjoys turnover-related rents that protect it from the impact of subdued trading. And lower volumes going through the high street stores have meant some more savings in distribution and staffing, on top of the extra savings found through operational efficiency.

The outcome of all this endeavour was that WHSmith was able to thumb its nose at the shorts today and sanction a £1m nudge up to overall group PBT expectations for the financial year to August from £105m to £106m. It also hinted at a very “encouraging” pipeline of new travel formats and store openings overseas, with more news to be set out at the interims in April: which will, literally, be Kate Swann’s swan-song!    

Whether the shorts will be right to think that WHSmith will eventually collapse when Kate Swann leaves in the summer remains to be seen. As long as the high street division holds its own and the key travel division can continue to spread its wings and grow overseas, her successor Steve Clarke will surely be able to protect her legacy.

If WHSmith was the wrong target for the hedge fund shorts, how did they get on with their other big bets ahead of the Christmas trading updates? Well, the bears got their fingers burnt in Home Retail, as Argos enjoyed the startling success of the tablet PC market and helped deliver a useful £10m upgrade for the group, despite weak trading at Homebase.

Elsewhere, Dixons was more of a score-draw, as the success in the UK after the demise of Comet and a “tablet-tastic” Christmas  was wholly offset by another disastrous time at the ailing ecommerce business Pixmania. And though Mothercare hit the headlines with its big UK sales decline, much of that was due to reduced promotional activity compared to the year before, whilst the vast overseas empire continued to show that Mothercare and Early Learning Centre remain aspirational brands for the burgeoning middle classes in developing countries.

The bears will have been disappointed therefore to see that Mothercare wriggled off their hook, but the other “M’s” provided richer pickings, in the form of the weak trading from Morrison’s and Marks & Spencer, the two big “losers” at Christmas. And the search for the next “loser” goes on, with Kingfisher the latest retailer to attract the shorts, ahead of its pre-close update on February 21^st. But that’s a story for another day…