Stockwatch: Time to accumulate this share

Is it time to consider the Argos/Homebase operator Home Retail again? Its Mid 250 shares have drifted from 2014/15 highs around 220p, recently down to 150p and are currently about 160p. The chart is typical of higher risk/reward stocks that soared in 2012/13 as loose monetary policy prompted risk-taking, consolidated in 2014 as exuberance wore off, and are now groping for a level. So what do the fundamentals suggest?

Joining the dots in a development plan

Group trading has recently been mixed with Argos sales slipping, but it's possible to trace a consistent strategy. When I initially drew attention three years ago at 90p the stock was a crowded short trade, yet the chief executive had just bought £123,000 worth and good progress was being made with "click-and-collect" marketing.

Its virtues are a vast range of goods to choose from online, customers can collect from their local store instead of waiting at home for a courier (or not be able to order at all, because they will be out at work). The Sale of Goods Act (e.g. items should work satisfactorily for reasonable time) is more easily enforced at a shop compared with Amazon's 30 days' replacement terms; and returns to Amazon mean re-packing the item and waiting in a Post Office queue. So click-and-collect can have definite advantages, and initially it helped Argos boost sales of tablet computers when these were the rage, enhancing the stock's 2013 re-rating. The 2014/15 results beat expectations with strong growth in normalised pre-tax profit and earnings per share as both Argos and Homebase achieved a second successive year of like-for-like sales growth.

Argos hurt by slower sales of older technology

But Argos - the group's main driver, representing 83% of the last financial year's profit and 72% of sales - has run into something of a hiatus. Quarterly updates reflecting the first-half 2015 calendar year cited like-for-like sales down 4-5%, explained as due to specific technology items slowing - TV's, PC's and tablets - although mobile phones have continued to do well. Analysts began to fret, this was saying something about the Argos format since the UK economic context has been strong with consumer confidence rising. Management offers hope that "the second half should improve as we look forward to introducing new Argos digital offers in time for peak trading".

An 11 June trading statement showed mobile phone sales helping to resist the decline and online sales continuing to grow from 42% to 44% of total Argos sales, helped by mobile commerce; and the gross margin edged up by 0.5%. Homebase made a good start to the financial year, sustaining like-for-like sales growth of 5.4%, although this was boosted by stock clearance sales which meant a 1.75% slip in gross margin.

Becoming "an Amazon with stores"

The table shows analysts taking a cautious view of forecasting, such that not even the 2016/17 year will match 2014/15's performance - as if the stock is best left alone for now. Yet Morgan Stanley has warmed to click-and-collect marketing, suggesting that Home Retail can become superior to Amazon in key respects, and investors should look beyond Argos's recently weak figures to understand the transformation underway. "If management's vision is realised, Argos could yet have a very attractive future." The company's new hub-and-spoke network can service hundreds, potentially even thousands of small stores, offering click-and- collect consumers a huge range of products at just a few hours' notice. Successful trials of Argos store "implants" at Homebase are being extended to ten Sainsbury's stores this summer, which individually get ten times the footfall of a typical Homebase store.

Morgan Stanley prevaricates somewhat, citing "significant execution risk...the company has already admitted to a number of IT issues...the biggest challenge will be getting consumers to understand the changes and reappraise the brand." But despite lacking confidence in how the Home Retail story may evolve over the next two years, "we believe there is scope for the shares to double if trading improves and investors buy into the transformation plans". This looks achievable given an improvement in earnings and their rating, I suggest over three years or so.

Cash and trade receivables limit downside

A fall from the current share price level would appear to need something going seriously wrong and/or a sharp recession; otherwise the end-February 2015 balance sheet implies limited downside risk. There was no debt and cash reserves were £309.3 million cash or 38.0p per share, while current assets included £790.0 million trade receivables (up from £712.1 million) versus £46.4 million trade payables, implying a net positive balance of 91.5p per share. Whether all of that could convert to cash is debatable, but nearly 130p per share could be considered cash or near-equivalent. This is significant versus a current share price of 162p.

Mind how the group is currently in the habit of booking exceptional costs, which still have to be paid despite income statements separating them off (£35.4 million last year after £41.4 million in the 2013/14 year). These involve investment in digital, head office and distribution centre restructuring, outsourcing IT and implementing payment protection insurance. It's quite a range of charges, which may persist, albeit small in context, equating to about 4p per share last year.

The balance sheet therefore underwrites the development plan allowing management time to fulfil its objectives; and if the UK economy does ease then Home Retail is not exposed with debts. Admittedly it requires some leap of faith, whether click-and-collect marketing can take this group forward in a big way, but with Sainsbury's now recognising strengths in the Argos format the currently weaker share price offers scope to accumulate.

For more information see homeretailgroup.com.