Home Retail Group - Study

www.prabhus.com January 2012

Contents

..................................................................................Problems Reported! 3

.......................................................................................................Scope! 3

....................................................................................................Analysis! 3

..........................................................................................Competitive advantage! 3

.......................................................................................Resources & Capabilities! 3

...................................................................................................Recommendation! 4

....................................................................................Argos - Homebase overlap! 4

.........................................................................................................Store Closure! 4

..............................................................................................Books and Clothing?! 5

.................................................................100% collection for Check & Reserve?! 5

..........................................................................Exit from Audio and Video games! 5

...................................................................................................In-store collection! 5

.......................................................................................................................Toys! 6

..........................................................................................Tracking Internet Sales! 6

..................................................................................................Endnotes! 8

2

Problems Reported

Argos like-for-like sales down 8.8% from September till December 20111

• Two-thirds decline in consumer electronics category particularly on video gaming and audio markets.

• Growth from iPad2 and kindle sales.

• Sales 35% down in video gaming category. Pulled-away from loss-leading deals.

Homebase like-for-like sales down 2.6%.

Group will be closing its UK homewares trial format.

Scope

We are going to limit the study to Argos alone. Data is collected only from public sources and for the year 2011 and 2012.

Analysis

Competitive advantageArgos claims to have low-cost advantage due to scale. We believe this alone may not

be enough to provide a competitive advantage and the group has to start thinking in terms of differentiating their offering. This would involve exiting un-profitable markets, establish-ing good brands and reducing the cost in the value chain.

Resources & CapabilitiesEstablished own-brand products.

• Bush and Alba in consumer electronics

• Chad Valley in toys

• Schreiber and Hygena

Second largest UK internet retailer with 400 million visits to the website.

3

Recommendation

Argos - Homebase overlapToo much overlap between Argos and Homebase as shown in the table below.

Store ClosureWe are recommending immediate store closures as part of the turn-around strategy.

Below are some charts comparing sales and store growth.

1092 combined stores appears too much and is not suitable for the current tougher environment.

Number of stores make just £25K to £100K profit per year.

4100

4175

4250

4325

4400

2007 2008 2009 2010 2011

Sales growth

Sales

900.0

950.0

1000.0

1050.0

1100.0

2007 2008 2009 2010 2011

Store opening

Stores

4

Books and Clothing?Need to re-evaluate the strategy behind selling books and clothing on a commission

basis. This brings them in direct competition to online retailers like amazon.co.uk, play.com and other clothing retailers.

Home retail cost base is just too high and is not suitable for this kind of business activities. This is evident from their “Operating and distribution costs” which has re-mained constant in pound terms compared to 2011, despite a fall in sales thus indicat-ing very high fixed overhead.

100% collection for Check & Reserve?Need to recheck the validity of check & re-serve percentage claim. (Refer to the chart on the left taken from the investor presentation). 100% collection rate may not be possible.

Exit from Audio and Video gamesWe recommend them to exit from markets like audio and video games where they cannot leverage their competitive advantage. In Terry Duddy’s (CEO of Home Retail) own words

“I cannot provide an own-brand version of video games consoles”.

In-store collectionOrder for in-store collection was launched for 4300 categories. This is different from the

in-store collection method offered by other retailers. In case of Argos, the customer need not pay upfront. Hence failure to collect would lead to Argos incurring the transportation and storage costs.

In-store collection Argos approach

Customer buys the product on-

line and gets the product delivered

to the store.

Customer reserves the product

and the product gets delivered to

the store. Customer can choose

not to buy the product.

5

ToysWe believe that Argos has a good opportunity to expand on Toys. There is a potential

to establish their Chad Valley brand as a competitor to Vtech, LeapFrog and other brands. For this to happen, Argos has to expand on the supplier base. Partnership with online por-tals like amazon.co.uk, play.com is a recommended option.

Tracking Internet SalesArgos doesn’t have a mechanism to track profitability of internet sales in terms of inter-

net based collection and home delivery.

In Richard Ashton (Finance Director), own words

“We have been asked this question before but unfortunately we do not run channel profitability, because it would just become a huge cost al-location model”

Their business model is not optimised for home delivery. Argos would prefer their cus-tomers to come to their store, pay using the quick pay kiosk, rather than order for home delivery.

We at Prabhu Consulting, tried to uncover some sales numbers related to home deliv-ery through internet. We started with the chart in their annual report.

In 2011, total internet sales was 35.9% out of 46%. 46% sales is equal to £1.9bn. This means £1.48bn in internet sales. (From 400mn visits).

6

• Check & Reserve internet - £1.065bn

• Home delivery internet - £417mn.

• Operating profit is 5.2% which equates to £21.68mn.

In 2012 H1, again 46% of total sales is multi-channel. 9.1% decrease from 2011 H1 and 11% increase in website traffic.2

• Total sales from internet has gone down to 33% from 35.9%.

• Again one-third of 33% i.e 11% represents home delivery from internet. 11% is £184.36 mn. (Total sales - £1.676bn)

• Operating profit for Argos is 0.2% (0.179% to be exact). If we assume the same for internet sales as well, we get £368,720. (£737,440 for internet based collection).

• We are guessing that in H1 2011, this profit would have been £5.39mn. (10.1% of 54.4mn profit. Source: Home Retail Investor Presentation, page 10). £14.04mn profit for internet based collection.

We believe the poor margin is mainly attributable to the operating and distribution cost. Even though Argos carefully tries to avoid cut-throat competition, their cost base is just too high. As explained earlier, store closures is a good start to reduce the cost base.

0

3750000.00

7500000.00

11250000.00

15000000.00

Delivery Collection

Operating Profit

H1 2011 H1 2012

7

Endnotes1 Home Retail Group - Q3 Interim Management Statement

2 Q3 Investor presentation, page 39.