Gamble of the week: A risky punt on carpets

If you are thinking of buying shares in the UK's largest seller of carpets, then virtually everything you hear or read about the company right now is telling you to steer well clear.

Selling carpets is a cut-throat business. Customers are always looking for a deal and plenty of sellers seem willing to cut prices to give them what they want. This makes it hard to keep your head above water when you have to carry the costs of renting stores and the staff that work in them.

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Carpetright (LSE: CPR), however, has survived and has a sizeable 25% share of the £1.5bn UK market. Yet, this business has so many red warning flags flying from it, it's not really surprising that lots of people are betting that the shares still have a long way to fall from their current 52-week low of 373p.

Last year, the chief executive walked out of the business. This year, the company's founder, Lord Harris of Peckham, has announced that he is planning on leaving and has been selling quite a lot of his family's shares recently shifting over £13m worth a couple of years ago. A venture into Europe has not paid off and is losing money.

What's more, profits have fallen a long way. Back in 2010, its trading profits were £34.1m and its operating margin was 6.6%. A decade ago, profit margins were in the low teens. Not looking good when you contrast that with last year's UK profits of just over £10m and marginsof just 2.5%. So why on earth would youthink about buying the shares?

If it can sell more carpets for a profitof 60p in the pound then there's scopefor profits to go a lot higher, as lots ofcosts are fixed. (That said, the normalcorrelation between mortgage approvalsand carpet sales seems to have brokendown at the moment.)

Costs can comedown from closing loss-making storesand renegotiating rents on about a fifthof the ones that remain. This is the betthat renowned value investor FranklinTempleton seems to be making. It hasbeen buying lots of shares and is nowthe largest shareholder with a stake ofnearly 20%.

Verdict: a very risky punt

Phil spent 13 years as an investment analyst for both stockbroking and fund management companies.