City Column - Argos under growing pricing pressure
In a lengthy 100-plus page report from Credit Suisse the broker seriously questions the future prospects for Argos and suggests it is not only its products that are now over-priced but also its parent company Home Retail Group.
On a PE of around 17x earnings for 2009/10 (at a share price of 293p last week) Credit Suisse reckoned the business was on an unjustified premium to the market and that its medium-term prospects - from both a sales and margin perspective - looked somewhat rocky.
Its gloomy conclusions led it to downgrade Home Retail from ‘Neutral’ to ‘Underperform’ and set a target price of 235p, which currently compares with a share price of 277.7p and a 12-month peak of 336.5p.
Although a third of Home Retail sales are derived from its Homebase chain, this accounts for little of the profitable growth of the group so arguably an analysis of just Argos should be sufficient to enable a view to be taken on the group’s prospects.
Such an analysis from Credit Suisse found the latest Argos catalogue (Autumn/Winter 2009) has ‘start’ prices 10 per cent higher than last year and that there is also a much greater emphasis on tactical promotions than previously, which is leading to greater volatility and therefore less visibility.
This scenario is the result of increased input costs and competition from Tesco, Asda and Sainsbury’s who are all aggressively growing their non-food offers, with the former pair running direct catalogues. This is a destructive cocktail for Argos and is highlighting some of the limitations of its model.
With the grocers undercutting it and consumers balking at its 10 per cent higher start prices Argos is reducing its pricing intra-season (or mid-catalogue) much more aggressively than it had anticipated. Such is the level of these cuts that it is having a tough time offsetting COGS (Cost of Goods Sold) inflation through its current catalogue, which is reducing its margins.
Proof of how Argos is struggling to compete on prices can be seen with its TVs. The Credit Suisse analysis found that in a survey of 20 branded TVs Argos was not the cheapest in any. This is particularly worrying as electricals account for 51 per cent of its total sales.
What has helped Argos over recent years is its first-mover advantage with having a multi-channel proposition, with its ‘check and reserve’ proving phenomenally successful, but the problem now is that the competition is catching up fast.
There is also the added worry that as more sales move online (40 per cent of Argos sales in 2008/9 were multi-channel) the internet’s transparency will harshly show Argos’ weakened price positioning. Added to this issue is the fact Argos’ catalogue has probably reached its final iteration in terms of page numbers so any range extensions are now available internet-only.
When you throw in the slowdown of internet penetration in the UK and Argos’ customer base being more sensitive to price increases then the company is going to have a fight on its hands to retain its place as the country’s leading general merchandiser.
Since it has successfully evolved its model over its 36-year history there is every chance it can retain its relevance into the future, but for now the downside case as put forward by Credit Suisse may be just a little too convincing for many investors at the present time.
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