Mulcahy's chain reaction

FOR a decade it was the company that could do no wrong. Kingfisher was lauded for turning round that basket-case to end all basket-cases, Woolworth. The business-graduate team parachuted in to save the business in 1982 had for years been regarded as corporate heroes.

The City's love affair with the company started to cool a year ago. Kingfisher earned the dubious distinction of being the worst-performing share in the FT-SE 100 index in 1994. But City investors and analysts were still not prepared for the bombshell announcement that appeared on their screens last Wednesday morning.

Profits at Woolworth would be down by a third this year, Kingfisher warned. Underlying sales at Comet, its electrical goods chain, had collapsed by more than 10 per cent and it would be loss-making this year. Even at B&Q, the normally reliable DIY products chain, margins were under pressure. Group profits for the year would be down. Worse still, the company hinted there could be a restructuring provision of up to £150m.

The City, which had been expecting a poor trading statement, was wrongfooted by its sheer awfulness. The shares, which sank 19p to 402p, their lowest since 1991, as analysts rushed to downgrade their profits forecasts, ended the week at 399p.

According to Hilary Monk of the retail consultants Verdict: "The Comet results were unbelievably appalling. We're flummoxed as to how they could suddenly be so bad."

Rod Whitehead, stores analyst with the investment bank Goldman Sachs and a former corporate development manager at Kingfisher, is equally shocked: "Two of the operating businesses have gone remarkably wrong in a very short period of time.''

Their sentiments were echoed across the City. Institutional investors were disappointed, and are expected to demand management changes.

How has it all gone so wrong? How have the wings fallen off the iridescent Kingfisher?

The company itself has been stressing that the problems are confined to just two of the six operating companies. B&Q, the toiletries chain Superdrug, the French electricals group Darty and the property arm, Chartwell Land, are all doing fairly well.

But some observers believe the problems centre on the head office, where the last two years have seen huge management upheaval. According to one source: "The top management took its eye off the ball."

As reported on page 1, the relationship between Sir Geoff Mulcahy, the executive chairman, and his chief executive, Alan Smith, the Marks & Spencer high flyer brought in two years ago, has not always gone smoothly.

Meanwhile, James Kerr-Muir, the finance director, who replaced the popular Archie Norman - headhunted to run Asda three years ago - has not inspired the same confidence among some analysts.

Another concern about the head office is the mushrooming costs. The boardroom payroll alone has rocketed from £1.75m to £3.27m in two years. Sir Geoff's annual package went up from £792,000 to £1.3m over the same period.

The headquarters in Marylebone Road, London, once a model of corporate thrift, has expanded from 40 staff to more than 100. A special strategy unit of management consultants, headed by former McKinseyite Tim Breene, has been created.

The total cost of the head office is now thought to be between £12m and £15m - acceptable in a business making profits of £330m and growing (as the general perception of Kingfisher was before last week), but less so in a business making perhaps £280m, and with much more questionable growth prospects.

Nigel Whittaker, director of corporate affairs, says part of the expansion was because audit work previously handled at operating company level was now done centrally. As for the strategy unit: "It's a choice between that and using outside consultants. It is working well.''

Sir Geoff's vaunted policy of Every Day Low Pricing - an attempt to escape the damaging round of price wars and promotions - has also come under fire. Although it worked well at B&Q, which is the market leader in DIY, with the clout to dictate policy, itwas less effective in the other businesses.

Whatever the problems at head office, the difficulties at Woolworth and Comet are undeniable. Woolworth is Kingfisher's biggest chain by sales, accounting for 30 per cent of the group's £4.4bn of sales in the year to last January. In past years it has contributed more than £70m to operating profits. But no longer.

Poor demand in November was followed by a distribution fiasco in December. In the end, Woolworth had to rent extra warehouse space. Even where sales were buoyant, they were in low-margin lines, such as confectionery and videos. Adding to the woes has been the heavy cost of installing scanning equipment in the shops.

But Woolworth's problems go much deeper than this, according to Tony Shiret, the stores analyst at brokers Barclays de Zoete Wedd, and one of the first analysts to go bearish on Kingfisher. The shops are tatty and the product areas are under fire from rival retailers. Argos and Toys `R' Us have aggressively moved in on toys, for example, while supermarkets have taken market share on confectionery.

Woolworth is now targeting newspapers and magazines, adult clothing and toiletries as areas for expansion. But each of these product areas is already highly competitive.

And that really illustrates Woolworth's problem. On one side it is fighting off the supermarkets, which offer the convenience of an ever-widening range under one roof. On the other are the specialist stores or "category killers", which beat them hands down for choice and service.

According to Hilary Monk of Verdict: "The first thing you notice when you walk into a Woolies is that it's half-empty. They've got all that space and, frankly, they don't know how to fill it. They desperately need to get a good reputation in a couple of other product categories.''

Rod Whitehead of Goldman Sachs says that Woolworth left it too late to introduce scanning equipment, but disagrees that the variety store, or five & dime, is becoming a retailing dinosaur. "What's Marks & Spencer but a variety store?''

It is, he says, a typically City view, held by people who do not visit the stores. "Don't forget the business has a turnover of £1.3bn and a huge customer base.''

The other immediate concern is Comet, Kingfisher's retailer of brown and white goods. It accounts for about 15 per cent of group sales, though a smaller proportion of overall profits. The 10.6 per cent fall in underlying sales was all the more surprisingbecause most electrical retailers are experiencing perky demand in most areas, with the exception of camcorders and games consoles.

For example, Dixons-owned Currys, Comet's closest competitor, has been enjoying a 9 per cent underlying sales increase in its superstores over an overlapping, if not identical period.

Analysts say that Comet has been strongly outpaced by Currys. At Comet, the stores are scruffy and the customer service often weak. Morale is at rock-bottom after two redundancy purges in 18 months.

Elsewhere in the Kingfisher empire, the prospects are better but not particularly rosy. B&Q has been a consistent profits contributor, but the DIY market remains highly competitive. If J Sainsbury succeeds in buying Texas Homecare, B&Q could be in for some much stiffer competition. The likely arrival of Home Depot, the aggressive American warehouse operation, adds to the uncertainty.

Superdrug, the toiletries chain, is a solid contributor to Kingfisher's bottom line, though in a mature market.

The fifth leg of Kingfisher is Darty, the biggest electrical retailer in France. There were some suggestions at the time that the £1bn in cash and shares it paid in 1993 was over-generous. Now, however, it looks the most promising business in the Kingfisher stable. Next year it should overtake B&Q to be the biggest contributor to group profits.

In total, Kingfisher is expected to report annual profits before tax and provisions of around £280m when it unveils its preliminary results in March. That is down from £309.3m last time. For the fifth year, the company will have to admit to flat or declining earnings per share.

It is all a long way from 1982, when Charterhouse, the merchant bank, led a consortium of investors buying the American Woolworth's 52 per cent stake in the British arm, and installed a trio of ousted managers from British Sugar. Two of them, Sir Geoff and Mr Whittaker, are still there.

They can boast that they have created enormous value for the shareholders who got in on the ground floor. But more recently arrived investors have seen more than £1bn wiped from their shareholdings.

While some investors are starting to regard Kingfisher as a low- rated yield stock, no one has yet seriously questioned the logic of the retail holding company structure. As long as the head office remained tiny and its management thoroughly competent, there was no need to.

But that may start to change. There are few synergies between the various operating companies, and, therefore, not many strong reasons to bunch them together.

The break-up value of Kingfisher cannot be much below the current market capitalisation of £2.7bn. Darty could probably fetch £1.1bn now, leaving the UK businesses with an imputed value of just £1.6bn. A predator might find that a tempting prospect for abusiness with sales of £3.7bn. Stores groups on average are valued at 0.9 to 1 times annual turnover.

Sir Geoff has a mighty task ahead of him in regaining the confidence of shareholders. But he is capable of radical thinking and may surprise his critics yet.