All the focus in the retail sector at the moment is obviously on Tesco's shock accounting problems.
But lower down the market there is some interest in WH Smith. Analysts at Barclays have looked at the growth potential for three businesses within the group - WH Smith Local (a small, so far, trial of franchise stores), international and Funkypigeon, and concluded they could be worth more than double their current values. Barclays' Richard Taylor said:
We estimate that these divisions currently generate earnings before interest and tax of just £4m (around 3% of group earnings), and are therefore largely ignored by investors. Over the medium term, however, we believe they could positively surprise the market and help the group continue its track record of strong free cash flow growth.
In our medium-term case, we believe that these emerging divisions could support a valuation of over £200m (172p per share), compared with just £71m (59p per share) today. This case is based on potential earnings of £15m. Our blue-sky case indicates potential earnings of £24m, which could support an even greater valuation.
We estimate that WH Smith Local currently generates no earnings. However, with 15 trial stores due to be open by 2014 year-end, we demonstrate that 200 stores (compared with around 20,000 newsagents in the UK) could generate £2.4m of earnings. This assumes revenue per store at an 80% discount versus a typical High Street store.
For International, we estimate that the division will generate around £2m of earnings in 2014. However, with 118 stores now open we believe that earnings will grow to £9m by 2017 as store productivity builds and 30-40 new stores are added each year.
Finally, we estimate that Funkypigeon will generate around £2m of EBITDA in 2014, lower than market leader Moonpig (£14m of EBITDA) despite having revenues of £13m in 2014, around 25% of the level of Moonpig. Applying Moonpig's EBITDA margins of 26% to Funkypigeon's 2014 estimated revenue implies EBITDA of £3.5m. According to press reports, Photobox, which is Moonpig's parent company, was considering an IPO that could have valued the business at £400m-£500m (source: Daily Telegraph) or a 2014 enterprise value/EBITDA of 20-25 times.
We continue to believe that WH Smith gives investors an attractive combination of strong growth, with an earnings per share compound annual growth rate of 10% from 2014-2017, backed up by strong cash generation, with a 7% free cash flow yield.
Barclays has an overweight rating and £12.50 price target on WH Smith shares, which are currently 13p higher at £11.22.
