Home improvement giant Kingfisher (KGF) reported a first-quarter trading update that supported our thesis of a robust performance in the U.K. and medium-term margin improvement.
Kingfisher has structural advantages over online competitors
Our positive view of the stock ultimately rests on the U.K. market, and the ability of management to execute on margin expansion across geographies. In the U.K. in the first quarter, there was modest upside to our estimates, with B&Q like-for-like sales down 1.1% despite a double-digit comparable a year ago and Screwfix up 15.4% on a like-for-like basis. Although this was broadly in line with our forecasts, we believe it provided modest upside to consensus. We expect Stamp Duty relief to support the housing market this year, while the election of the Conservative government removes the overhang of a "mansion tax" being imposed by the opposition.
There was little inflection in any of the core markets, as France continued to be weak and the U.K. and Ireland performed reasonably well. We are reiterating our narrow economic moat and stable moat trend ratings as we think Kingfisher has some structural defences against online competition. Our £4.30 fair value estimate imply upside to the stock from current levels.
Kingfisher's other core geography remains weak, however, with industry sales in France again falling due to the weak housing market. Brico Depot like-for-like sales of negative 1.9% narrowly missed our internal estimates, driven by a further contraction in housing construction. We are likely to maintain our near-term forecasts for both Castorama and Brico Depot, however, even though our full year estimate now implies a return to positive like-for-like sales by the end of the year, as the comparables become easier throughout the year.
In our in-depth 2014 report, we identified the categories in which Kingfisher has structural advantages and pricing power over the online channel. The categories include high ticket purchases in kitchens, bathrooms, and flooring. In these categories, customers almost always visit a store to see products in person, and are limited in their ability to find identical products elsewhere because of the exclusive product ranges on offer. In low priced and commoditised categories, however, Kingfisher's retail banners do not possess pricing power.
In addition, we believe there is scope to increase the number of common products sold across business units, which currently stands at just 7%. Differing building standards and interior design tastes and preferences mean that Kingfisher will always have a significant level of local products in its stores, but the strategy to leverage common products across markets should be margin-accretive in the medium term. We do not believe it will be necessary for Kingfisher to achieve the mid-teen margins of its U.S. counterparts Home Depot and Lowe's in order for the stock to be rerated, however, and our valuation implies a low single-digit margin improvement to 7% by 2019.
