WH Smith (SMWH) was recently voted the worst shop on the high street by the Consumers' Association Which? - quite an accolade considering the contenders. But does poor customer experience visiting its stores translate into a bad investment case? The general view from fund managers is "no".
In fact, Callum Abbot, co-manager of JPM UK Equity Core, believes the exact opposite is true. He notes that WH Smith has languished in the bottom two high street shops in the Which? survey for the past eight years running. In that time, its share price is up around fivefold.
That’s in contrast with other retailers with longstanding bricks and mortar estates, who continue to struggle to lure customers to their shops and, as a result, lose out to internet-based competitors.
“The reason why the share price has performed well maybe gives a bit of a clue as to why people don’t hugely like it as a shopping experience,” says Abbot.
He explains that WH Smith has squeezed its estates so much that it’s not surprising the customer experience is not very good. “If you’re really sweating your assets, you’re probably not going to change the carpet and you let the store get a bit run down.”
Some respondents to the Which? survey also commented that WH Smith is expensive – arguably not surprising if the company has managed to squeeze its suppliers on prices, but not passed that on to consumers.
Sales Have Fallen
WH Smith has not been immune to the high street’s travails. High-street sales have declined every year since 2003, more than halving in that period from £1.4 billion to £610 million. However, management has begun to focus on more high-margin items such as stationery and food-on-the-go and stopped selling low-margin items such as CDs and DVDs.
As a result, since its 2006 demerger, retail sales have fallen by 40%, but operating profit has shot up 48% in the same time. “They have completely offset that revenue decline by growing margin. Margins have gone from 4% to 10%,” says Abbot.
In contrast to the retail business, sales in its travel division have been booming. Revenues here are up almost 250% since 2003 and have almost doubled since 2006. Last year was the first in its history that sales from travel have been higher than from the high street.
The division, which include its outlets in rail stations, motorway service stations, airports and hospitals, now accounts for 60% of group profit. “And that is only going to get bigger,” claims Steve Davies, manager of the Jupiter UK Growth fund.
The attractions of this division are obvious, especially for those who regularly travel by train. You have a captive audience that have few places to go to stock up on food and drink before a long journey. This allows them to charge higher prices than usual, making it a high-margin business.
With expectations that travel will continue to blossom, the next port of call is to expand its airport offering internationally. It has already begun this process, with a presence in 25 countries outside the UK, but it still only has a 1-2% market share there, according to Abbot.
Davies says people underestimate WH Smith here, despite them being “genuinely world-class” at travel retail.
“When they go and compete for contracts in Spain or Australia their pitch to the landlord is that ‘we’re so good at this compared to your existing operator that the sales will go up 10, 15, 20% and you’re on a turnover-based rent so the more we sell the more you’re going to get paid’.”
Dividend Hero
Alongside this is its extraordinary track record at returning cash to its shareholders. “With all this profit and cash being generated, they’re very clear in what they do with it – they just give it all back to us,” says Davies.
It’s returned almost £1 billion to shareholders since 2007 through ordinary dividends, special dividends and share buybacks.
The total ordinary dividend has increased in every year since 2007 – in fact, this year was the only time it’s not done up by a double-digit percentage year-on-year – and is up fourfold in that time to 48.2p for the year ended August 2017.
The Jupiter fund’s holding in WH Smith predates Davies being named manager in 2007. This is because when Davies was a sellside analyst, he encouraged his predecessor to look at the stock. So, clearly he’s a long-time fan.
One of the reasons he likes the company is the quality of its management team. “The one thing I would say is that WH Smith is one of the most analytical, hard-headed, cold-hearted retailers that I’ve ever come across,” he says.
“That’s one of the key reasons it’s been able to adapt and change. If you went back to the mid-2000s and put it alongside Woolworths, you’d have said both of them are equally challenged and yet one of them has gone bust and the other has gone up fivefold.”
There were worries when former chief Kate Swann stepped down in 2013 to join rival SSP. At the time, she had taken the share price from around £3.50 to £8. But her successor, Stephen Clarke, has done even better. In his five years at the helm, he’s taken the stock from £8 to £20 today.
Then there’s valuation. Clearly, the stock has performed tremendously well on a share price and total return basis. But with that comes a question of whether it’s run far enough. Broker Cantor Fitzgerald Europe, for example, has the stock only on a hold rating.
Abbot says his fund has had been on and off for a long time, selling periodically on valuation grounds. However, he’s currently modestly overweight WH Smith versus the benchmark, compared to structurally underweight retail in general. He last bought shares around a year ago.
Davies says that when you compare WH Smith with standard retailers its valuation looks on the high side. However, it’s now almost exclusively seen as a travel retailer, which is a higher multiple business. When you look at travel retailers globally, there are some quoted names that are on even higher multiples than WH Smith.
