Recent Trading Update

Argos’ most recent trading results for the six months to the end of August 2011 really jumped off the page (or to be precise, screen) at me. The results were spectacularly awful even by the standards of some other recent retail trading updates. Specifically:

• Like for like sales down 9.1% (ie. those sales made from the same units open in both periods)
• Consumer electronics category’s sales down even more significantly
• Gross margin down nearly 1% (which equates to circa £17m on sales of £1.7bn)
• Operating and distribution costs reduced by only 2% over the same period
• Therefore 94% of Argos’ operating profit of £54.4m generated in the same period last year has disappeared and operating margin % is now wafer thin at 0.2% of revenues as a result
• Whilst not quoting any updated sales figures since August (which tends to speak volumes in itself), Argos admitted that sales had not subsequently improved to the extent anticipated by management

Whilst Argos has had their critics in the past, one cannot argue with the historic success of the business. I would summarise those historic strengths as follows:

• A wide range of product, highly competitively priced
• A collection outlet on most high streets
• Whilst clearly skewed social-economically towards the C2/D/E market, Argos has always retained a relative classlessness not managed by, say, the supermarket discounters
• Considerable power (as with the big supermarkets) over their suppliers to control prices and product returns levels
• “Category killers” in various sectors (toys at Christmas being a good example)

What's the problem?

So is Argos a victim of the general economic malaise or are there other factors at work? Yes and no is the answer really. There is no doubt that Argos shoppers (as elsewhere) are cutting down on discretionary spend (which explains the dire results in the consumer electronics category for example) but (somewhat like HMV) Argos continues to operate in somewhat of a timewarp whereas their competitors have grown up and moved on

What I am thinking of when I say this, is the historic model where the shopper was forced to spend time in a depressing showroom-type store, filling in an order form from well-thumbed catalogue with a micro-biro and then sitting (as if in a doctor’s waiting room) for the product to arrive. Ambience and customer service were negligible. I put up with this because of the range and price benefits noted above. The experience in my view has not changed markedly (although one can now pre-order via the internet before visiting the store; personally with mixed success) but the world has, even for the core Argos customer

Channels to market are being invented (or often re-invented) and Argos has had to think about how, for example, mail order and TV shopping can generate more sales for them and even about producing applications for mobile devices. All this dilutes the simple proposition that worked so well in less complicated times. New competition has entered the market with the supermarkets continuing to expand their non-food ranges. Supermarkets can be at least as price competitive as Argos now, whilst there is also the convenience of “everything under one roof”. As a result, Argos has been forced into new product categories such as clothing and books where their merchandising and ranging abilities are not necessarily as sure

Argos has had to become even more price competitive in the face of strong competition but the problem is that when gross margins are already cut to the bone, then there is really nowhere else to go when sales fall unexpectedly. What the latest results have demonstrated is that a retailer suffering a severe and unplanned sales shortfall (particularly where there is little scope to mitigate the fall with gross margin increases) will almost inevitably suffer a significant bottom line deterioration (the simple laws of mathematics applying). Whilst Argos say in mitigation that they have cut operating and distribution costs by 2% in the period, this is not as impressive as it appears. All retailers need to cut variable costs as best they can in line with sales shortfalls. What appears to have happened at Argos is that either this discipline was not sufficiently in place or management avoided cutting costs in the hope that a sales decline earlier in the period did not become a semi-permanent trend