The retailer has long proved the doomsters wrong it's likely to keep doing so, says Phil Oakley.
Newsagent group WH Smith has become adept at proving the doomsters wrong. Its shares have been a fantastic investment in recent years. The price has soared, and shareholders have also received big increases in dividend payouts.
On top of that, the company has generated bucketloads of cash and juiced up returns even more, buying back more than £270m worth of shares. Since 2008, more than half the company's current market value has been returned to shareholders.
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It's not hard to see why investors might have been tempted to give the shares a miss. In the eyes of the uninformed, WH Smith is a tired high-street retailer selling stuff that people can pick up cheaper in the supermarkets or over the internet. How on earth can this business survive in the long term?
Yet survive it has. Under the leadership of Kate Swann, the company has ruthlessly cut costs. It has stopped selling unprofitable products and focused on goods that gave a bigger bang for its buck. Since 2008, sales from the high-street stores have fallen by more than £200m, yet profits have risen by £9m.
Elsewhere, the firm has a healthier travel business. It has shops at airports, railway stations, hospitals, service stations and workplaces. Here, WH Smith is able to benefit from the fact that it faces little competition and has a captive customer base. ]
It's not really surprising that this business makes more money than its high-street shops. Since 2008, sales are up by £47m, with profits increasing by £25m.
But surely retailing is ultimately about sales, not cost-cutting. After all, what happens when there are no more costs to cut? If more money isn't coming into the company's coffers from selling more stuff, then profits will start going down. So can WH Smith build a sustainable long-term business? Or is it set to hit the buffers?
Tough challenges ahead
As a result it has been able to generate lots of surplus cash to shrink the number of shares in issue and to pay out bigger dividends on the ones that remain. The stock market has given this a big thumbs up.
But can it keep cutting costs? New CEO Stephen Clarke thinks it can. It took out £18m in costs last year and reckons it can slim down by a further £22m over the next three years, with initiatives such as better buying and more self-service tills. But what about sales growth? On the high street, this looks to be a tough challenge.
WH Smith has been signing up more post offices for its stores and this should improve footfall. It is also making a major push into ebooks via its partnership with Kobo, a maker of e-readers.
Meanwhile, its FunkyPigeon.com greeting cards are doing quite well. Keeping sales static at least would be a decent achievement and would help WH Smith to continue to produce lots of surplus cash.
The travel business looks like more of a potential growth area, and this could make WH Smith a more valuable business. Passenger numbers through British airports are still 15% below pre-recession levels, but should bounce back if the economy continues to recover.
The company is opening more shops in Britain and abroad and this bodes well for future growth. As with the high-street side, WH Smith reckons that it can still increase its profit margins in this area of its business.
Should you buy the shares?
Throw in the fact that WH Smith has no debt and a return on capital employed (ROCE) of 20% more than double what Sainsbury's is making when its rented shops are put back on to its balance sheet, and you can see that WH Smith is a very profitable business.
The dividend yield of 3.7% is not to be sniffed at either. This is comfortably covered by cash flows, with the surplus being used to buy back another £50m of shares this year. City analysts are predicting that earnings and dividends will grow by 10% for the next two years.
Another point to bear in mind is that, in terms of sentiment, this is still quite a contrarian stock to buy. There are still many investors out there betting that WH Smith shares will come a cropper.
These investors are betting against the shares by going short' they are borrowing shares from other investors and selling them with the hope of buying them back cheaper at a later date.
If WH Smith continues to keep growing its profits, then this trade could become very expensive, which would force these investors to buy back the shares and push the price up (a short squeeze'). All in all, it looks like it's far too soon to write off WH Smith the shares are a buy.
Verdict: buy for dividend growth
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