Merryn's Blog

We don't like retailers - but this one is too cheap to ignore

There are plenty of reasons not to like retailers. But if you like a bit of risk, this potential takeover target is just too cheap to ignore.

How would you like to find a well-known UK stock on a p/e of five and a yield of 10%?

And no, I haven't got the figures the wrong way round.

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High street retailer HMV (LSE: HMV) is the name of the company.

It runs 272 HMV stores in the UK and Ireland, with 1.5m square feet no metric measures here of floor space. There are 129 outlets in Canada, and seven in Hong Kong. Then there are 314 branches of Waterstone's the booksellers.

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Group sales total £2bn - 33% 'visual' (that's DVDs and Blu-ray), 28% books, 21% music and 18% games. The group made profits of £44m from continuing operations last year. Long-term debt is just £5m.

10-03-04-HMV

So what's the catch?

First, HMV is in retail which isn't exactly a sector we like. Low wage growth, many more public sector job losses and likely higher taxes post-election aren't good portents here. But for now, consumer confidence is rising again, says the latest Nationwide survey.

Second, sales are under threat from internet retailers and supermarket chains. But rivals such asBorders, Woolworths and Zavvi have collapsed, leaving Waterstone's which has been struggling - as the only specialist bookseller on the high street.

Third, despite the price fall, HMV still isn't an 'asset play'. It doesn't own any of its shops, so it has to pay rent bills on all these regardless of sales. But last year, admin costs were just 4% of turnover.

So there are risks. This isn't a share, as the old stock market adage goes, for widows and orphans. Yet on the consensus of analysts' forecasts, HMV at 72p is clearly as cheap as chips.

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That could soon catch the eye of a bidder. Indeed, "the City is abuzz with talk of HMV searching for a new master", says Rosamund Urwin in the Evening Standard. The shares look so cheap, they could even attract a venture capital buyer, says Nick Bubb at Arden Partners.

"Management are very focused on realising shareholder value, and we expect the market to give the group more of the benefit of the doubt", he says. "If not, HMV will be very vulnerable to a private equity bid. Either way, we target a bounce back to 95p".

In other words, shareholders win either way. If you're open to taking a bit of risk, we reckon the stock is a buy.

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