Bargain hunters beware

Blue Chip: After a disastrous slump, House of Fraser is still some way from solving its problems

House Of Fraser, the department store chain, and once part of the Al Fayed brothers' empire, has been exposed to the public gaze for a little over two years. For investors who bought shares at the time of the flotation in 1994, it has not proved a particularly pretty sight.

Since the shares were listed at 180p, in 1994, they have slumped disastrously to their current level of 151.5p. Shareholders have become almost inured to fresh disaster at each set of results.

Surely, though, there must be some mistake. The High Street, so we are told, is booming; retailers in general are perking up. Not so, however, at House of Fraser (HoF), where the last set of results revealed dire problems continuing to beset the group.

First-half losses of pounds 13.6m were up from first half losses in 1995 of pounds 4.3m. Sales of women's wear fell 14 per cent, although sales from in- house concessions were up 29 per cent. The company's response was to announce the closure of up to 10 of its 51 stores, and a restructuring charge of up to pounds 50m.

When HoF was floated, investors assumed there were no problems in the business. So why the group is in this predicament remains something of a mystery. John Lewis - much larger, but as good a comparison as any - has successfully traded its way out of recession.

Other stores groups to have suffered the epithet of hopeless basket case - Next and Burton spring to mind - have shown that under good management, what seemed irredeemable can be retrieved.

In a frank admission of its problems, HoF management has confessed to analysts what it is up against. Among the more pressing concerns are: lack of information on customers; an unfocused business strategy; weaknesses in senior management, including the absence of a merchandising director for 18 months; poor planning; weak stock control; poor central distribution; and inadequate technology. A daunting list, but John Coleman, brought in as chief executive in May, can see light at the end of the tunnel.

Women's wear is among his first tasks to correct. Although it counts for 29 per cent of sales, it has been on the slide for 18 months. Men's wear, by contrast, has stormed ahead. But the greater effort on building men's wear, saw women's clothing lose out. The lack of a merchandising director also meant there was less focus on buying the right ranges and designer labels.

That problem has now been tackled by the company, who claim they have identified three typical female clothes shoppers at its stores: the quality classic, the smart career mover and the fashion lover. Inevitably, there is some overlap between the three groups.

Mr Coleman said at the time of the interim figures that this more precise targetting had already halted the deterioration in this area.

Homeware has also been moribund for the last few years. Mr Coleman proposes to focus on some niche areas where margins are profitable and sustainable, such as tableware and bedroom furnishings. So some lines - such as electrical equipment which is competing with major specialist retailers like Comet - will be reduced.

Finance director Richard Scott says the impact of the improvements won't be felt fully until the second half of next year. "Investors should see some improvements in costs by the time of the next full year figures, but margins will not show much change until the second half of 1997." It will be, he says, more a case of gradual improvement over the next two to three years.

The next major announcement is expected in the New Year, when the company will reveal which stores it intends to dispose of. Between five and 10 stores are on a hit list, assessed on customer profiles, profitability and efficiency ratings, as part of a wider operational review of every store in the group, now underway. Further details on this should be announced at the time of the next interims.

HoF is also curbing its previously expensive habit of modernising and refurbishing a store in one single, massive and extremely disruptive overhaul. Future refurbishment will be geared to keeping stores open and functioning while the work goes on. Hardly an earth-shattering management technique, but a step in the right direction.

The problem of House of Fraser for an investor is simple. Has management put its house in order, or are the problems more deep-seated? If the former, the shares are probably undervalued, which may account for the City gossip doing the rounds last week that HoF would be the subject of a hostile bid. The chairman, Brian McGowan, however, said he had not had any bid approaches since the rumours first surfaced a year or so ago.

Whether a bid materialises or not, HoF still boasts several attractions. Its mix of leasehold and freeholds gives it a strong asset base. Mr Scott points out that the assets support the dividend.

With the dividend looking secure, and ardent declarations that the worst is over, there is a view that the shares are poised on the brink of recovery. If that proves to be the case, and John Coleman's promises come good, then clearly the shares could outperform the market.

But there is the fear that while the pounds 40m-plus restructuring costs may address most of the problems, more trouble could be lurking just around the corner.

At present the shares trade on anything up to 30 times forecast earnings in 1997. That is leaving a lot to chance. With little to show yet in the way of a track record among incumbent management for solving - as well as addressing - the problems, the shares are best probably avoided. They may look like the next best thing to a bargain in the January sales, but there is no chance of a refund if they don't meet expectations.

House of Fraser

Share price 151.5p

Prospective p/e 22.5*

Gross dividend yield 4.8%

Year to 31 March 1994 1995 1996 1997* 1998*

Turnover (pounds m) 1,029 754.7 748.9 795 859

Pre-tax profits (pounds m) 68.3 28 14.3 19.5 38

Earnings p/s (p) 19.9 8.2 5 6.3 11.6

Dividend p/s (p) n/a 5.5 5.5 5.5 6

*NatWest Securities forecasts