More on Boots
Boots
Boots’ chemists shops, its largest business, are increasing sales though price cuts and there is some evidence that margins are being maintained, while Boots Healthcare International, its manufacturing business, continues to perform well. It has closed down most of its “health services” chain apart from Boots Opticians which is tiny, making just 0.6% of operating profit.
Boots the Chemists (UK retail) has cut prices since last year, by 4.9% on average according to the first half results announcement, although the cuts were concentrated on toiletries (down 12%). This has succeeded in increasing footfall and volumes (+6.8%) but has squeezed margins and the 24% drop in operating profit was what drove the decline at group level. Boots had little choice but to cut prices - it was facing a slow decline as supermarkets drove down prices. It is now in a position increase, volumes and turnover, but there is little prospect of reversing the decline in margins although gross margins were stable in the third quarter. While it looked during the third quarter as though Boot’s strategy was being comparatively successful, the profit warning in March suggests the fourth quarter (and the outlook for this year) will be weak.
Boots Healthcare International, the manufacturing business, continues to perform well with local currency sales up 4.8% and profits up 9.5% in the first half of the year, although the rise in sterling meant the reported increases were only 3.8% and 6.5% respectively. It continued its strong performance over Christmas with third quarter organic sales growth of 3.7% although total growth was a little lower as some brands were sold. This business has an excellent track record and its strong brands provide a good platform for brand extending product launches (recent examples include Clearasil for Men). Unfortunately this business only generates 15% of operating profit before loss making operations and central costs costs, so group performance is dominated by Boots the Chemists which generates 84% of operating profit at the same level.
Boots has exited health services apart from the opticians which is small and will become part of Boots the Chemist.
The increase in working capital (£276m in the half year) has turned operating cash flow negative. In addition capital expenditure has risen by £52m, and unlike last year it is not being significantly offset by cash inflows from disposals. Given that margins are likely to remain low we are very sceptical about the returns on this investment.
The impact on sales of cutting prices is encouraging and with costs being better controlled full year results should show further improvement.
The historical PE of 13× (at 636p) is not cheap given the weak outlook for the biggest business but the yield of nearly 5% is good (one of the highest in the sector). Pricing and margins as competition from supermarkets intensifies remain the key concerns..
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