Argos and Homebase owner Home Retail Group (LSE: HOME) surprised investors this morning by announcing plans to shut 25% of Homebase stores alongside its first-half results.
The results themselves werent bad like-for-like sales were up 2.9% at Argos and 4.1% at Homebase, and adjusted pre-tax profits were up 13% but Home Retails decision to shut 25% of Homebase stores by the end of 2018 suggests that there are underlying problems at the DIY chain.
Slim profits
In todays announcement, Home Retail said that low sales densities were resulting in a challenged financial model for Homebase. Translated, this means that the companys sales are spread too thinly across its stores, resulting in poor profitability.
This becomes obvious when you compare Homebases profits to those of B&Q and Screwfix, which are owned by Kingfisher (LSE: KGF). Homebase reported an adjusted operating margin of 3.3% for the first half of this year, less than half the 6.9% operating margin generated by B&Q and Screwfix over the same period.
Heading for trouble?
Home Retail may manage to solve its Homebase problems, but Im also concerned about Argos, which accounts for 66% of Home Retails sales. Argos reported an operating margin of just 0.7% for the first half of this year, and thats an improvement on the same period last year!
Home Retail Groups overall operating margin is only 1.1%, and for me, thats very risky, and could easily threaten the companys below-average 2.2% dividend yield.
Better buys elsewhere
Kingfishers overall operating margin during the first half of this year was 6.4%. With net cash in the bank, a 4% prospective yield, and a P/E of 13, the downside risk seem limited to me, and I rate Kingfisher shares as a buy.
Similarly, home furnishing specialist Dunelm Group (LSE: DNLM) appears much better able to cater for UK shoppers needs than Home Retail Group. Dunelm reported an impressive 15% operating margin last year.
Dunelm has grown its dividend by an average of 27% per year since 2009, and currently offers a prospective yield of 2.6%. Although the firms shares trade on a more ambitious forecast P/E of 17, I feel that this is less risky than Home Retail Group, whose shares trade on a forecast P/E of 14, despite Home Retails borderline profitability.
For me, Home Retail is a share to avoid, especially when so many better options are available.
Of course, you may not agree with my view: Argos and Homebase are both well-known British brands with a proud history.
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Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
