Fly away from Kingfisher

GENUINE recovery stories are among the most difficult investment situations to assess. The retail sector is full of them - and many missed opportunities. Who, for example, would have been brave enough to buy Next at 121/2p five years ago and stay all the way for the subsequent 40-fold share price increase? Similar nerves of steel would have been required to back Burton from 40p in 1992 to 144p today.

Now Woolworths-to-Superdrug retailer Kingfisher is being touted in the City as the sector's next growth stock, though investors may feel they have missed out on much of the fun.

The shares, the worst performers in the FTSE-100 index in 1994, have risen by almost 50 per cent since coming off a four-year low last year when problems at Woolies and the Comet electrical retail chain forced the departure of the chief executive and three other directors.

Into the breech stepped pounds 1.3m-a-year Sir Geoff Mulcahy, the former executive chairman, who was given 18 months to justify his appointment.

A reminder that Sir Geoff was living on borrowed time came in a recent poll of leading fund managers. They lumped him with P&O's Lord Sterling and Inchcape's Charles Mackay as the executives of underperforming companies who should be most worried about losing their jobs. Mr. Mackay subsequently did.

But recent results appeared to vindicate the Kingfisher board's confidence in Mr Mulcahy, if not the overall strategy. Recovery at Woolies produced like-for-like sales growth of 6 per cent and profits 27 per cent higher at pounds 65m as the benefits of a new electronic point-of-sale system finally came through. Comet crawled into the black, even if margins of 0.5 per cent remained unacceptably low. And French electrical retailer Darty, which cost shareholders pounds 1bn in 1993, shrugged off the effects of strikes to turn in another robust performance.

"Kingfisher has confirmed its ability to avoid basic mistakes and has allayed some of the market's worst fears," broker NatWest said last week.

Henderson Crosthwaite's retail follower Roy Maconochie is even more upbeat. "The results established the credibility of the recovery at Woolworths and Comet. This is a late-cycle recovery story."

But with its diverse retail formats lacking a coherent strategy, fire- fighting is never going to be far away at Kingfisher. And so it has proved again, this time at the DIY operation B&Q, where profits crashed by a third last year to pounds 55m.

A sluggish housing market alone does not explain the shortfall. Sir Geoff, who has denied reports that B&Q boss Jim Hodkinson is about to be offered up as a sacrifice, nevertheless admits too much time was spent on new B&Q store openings and not enough on managing the existing business. Only four of the planned nine vast Warehouse sheds, which cannibalise the troubled B&Q Supercentre chain, will open this year.

Such reining in of expansion plans also questions the whole growth strategy on which the recent share price surge was predicated.

The main plank of this programme is further expansion into the electrical retail and DIY markets in Europe. It is a prospect that would increase Kingfisher's risk profile without necessarily raising the level of rewards to shareholders.

"I just see dilutive deals like Darty happening again and again," says Richard Edwards of broker ABN Amro Hoare Govett. "The return on shareholders' funds is likely to be low."

He estimates that Kingfisher's return on capital is about two percentage points lower than its cost. When a situation like that arises, he argues, the share price invariably goes down.

Other analysts wonder if Kingfisher is that well placed to benefit from a pick-up in UK consumer spending as interest and mortgage rates fall. While all divisions, including B&Q, are said to have made a good start to the year and Kingfisher looks set fair for pre-tax profits of up to pounds 335m (compared with pounds 287m last year), Darty, the French subsidiary, still accounts for about a third of operating profits.

Against this backdrop, the promised year of consolidation does not appear to justify the recent share price run, while doubts about where growth is going to come from raise questions about the premium rating. All of which makes climbing on board this particular rollercoaster far too risky. Avoid.

Kingfisher

Share price 602p

Prospective p/e* 30

Gross dividend yield 3.6%

Year to 31 January

1994 1995 1996* 1997* 1998*

Turnover pounds 4.48bn pounds 4.83bn pounds 5.28bn pounds 5.71bn pounds 6.17bn

Pre-tax profits pounds 311m pounds 285m pounds 287m pounds 325m pounds 370m

Earnings p/share 37.1p 31.2p 31.6p 35.1p 39.0p

Dividend p/share 14.9p 15.2p 16.2p 17.5p 19.5p

* NatWest Securities forecast