Margins narrow after shift to video games from furniture

By Loveday Morris  |   2008-6-13  |     NEWSPAPER EDITION

HOME Retail Group Plc, the owner of UK store chains Argos and Homebase, fell to a record low in London trading after a shift toward sales of video games and consoles caused Argos's margins to narrow in the first quarter.

Home Retail slid as much as 12 percent, the steepest drop since the stock gained a listing in October 2006, as the company said the chain's gross margin, or profit as a percentage of sales, narrowed by 1.25 percentage points. That was worse than the 0.4-percentage-point decline expected by 10 analysts surveyed by Bloomberg News.

Sales at Argos stores open at least a year were unchanged in the quarter.

Argos, whose 709 stores sell everything from jewelry to power tools, increased sales of video games and consoles by "almost triple digits," Home Retail Chief Executive Officer Terry Duddy said on a conference call. That helped the chain beat analyst estimates for a 2.3-percent drop in same-store revenue, though margins narrowed because gaming is less profitable than the likes of garden furniture, sales of which were hurt by wet weather.

"It's likely that the trend of having more games in the product mix, and therefore lower margins, will continue throughout the rest of the year and that will lead to further pressure on earnings," MF Global analyst John Guy said yesterday. He has a "neutral" rating on the stock.

Home Retail slid as much as 26.25 pence to 197.5 pence in London trading and traded down 7.4 percent at 207.25 pence. A close at that price would be the lowest since the company was spun off from GUS Plc in 2006.

The shares have declined 38 percent this year on concern about the outlook for house prices and consumer spending. Citigroup Inc yesterday cut its rating to "sell," saying the UK has not reached the peak of this "brutal slowdown."

"Argos sales were slightly better than feared, but this was more than offset by worse margin performance," Matthew McEachran, an analyst at Kaupthing Singer & Friedlander in London, wrote in a research report.

Revenue drop

Same-store sales at the chain, which accounts for more than 70 percent of group revenue, slowed from a 1.9-percent gain in the preceding eight weeks. Revenue on that basis fell 12 percent at the Homebase home-improvement chain, worsening from a 5.3-percent drop in the preceding eight weeks.

Homebase's gross margin widened by 1.25 percentage points, better than the 1-percentage-point growth predicted by analysts.

Total first-quarter sales gained 4 percent to 929 million pounds at Argos and slipped 5 percent to 440 million pounds at Homebase. Home Retail said it is sticking to its full-year financial forecasts, without being more specific.

Duddy said he would be "surprised" if same-store sales improved at Argos this year, and said he expects a "small decline." Home Retail has predicted shrinking sales at both its chains in the "short term" as higher food and utility bills sap disposable incomes, leaving shoppers with less money to spend on household goods and furniture.

Homebase's same-store sales drop exceeded the 11-percent decline analysts expected. Revenue from "seasonal" goods such as garden furniture and barbecues declined by 20 percent on that basis, Duddy said.