Security: LSE:SMWH
Date of first purchase: August 18, 2010
I am buying shares of WH Smith plc at $6.35 per share (including commission) because I believe the business is actually worth $9.18 to $10.94 per share. This implies that the intrinsic value of WH Smith is between $1.4 billion and $1.6 billion, despite a current market capitalization of $955 million. Given the company’s $215 million tangible net worth, WH Smith’s intangible assets, such as its operations, market share, and brand, are effectively on sale for $740 million, a 45% discount to the bottom range of their true value. This margin of safety should allow considerable room for error or adversity if in the long run I have wrongly appraised the true value of ownership.
WH Smith is the United Kingdom’s largest neighborhood retailer of magazines, newspapers, books, and stationary supplies. A 218-year old company, it achieved its current stature in British business and culture through locating itself conveniently on virtually all of the country’s high streets and supplying Britons with low-cost print media and impulse products. But over the past two centuries, it has at times strayed from its core (which is both surprising and unsurprising given its longevity). WH Smith has been an owner of music retailers, newspaper distribution operations, and a variety of other dissimilar, low-margin businesses. This lack of focus culminated in the largest loss in the company’s history of $267 million, before current CEO Kate Swan took the helm. Ms. Swann and her management team simplified the company down to its most profitable businesses. The company now operates in two segments: High Street and Travel. Its High Street segment contains the defensive neighborhood convenience stores on which WH Smith built its reputation. The Travel segment contains small, high-margin outlets located in areas with heavy foot traffic, such as airports, hospitals, workplaces, and bus and train stations. With a renewed focus on the two businesses in which the company has its strongest market positioning, management has been able to reduce costs, improve scale, and increase profitability. In doing so, it has seen a decrease in top-line revenue from $4.5 billion in 2004 to $2.2 billion in 2009 as it has shed or wound down low-margin channels such as DVD and CD sales. This top-line decrease has possibly created fright and confusion among market participants voting on the price of WH Smith shares, especially in light of the British government’s recent austerity measures. However, it is unlikely austerity or its effects will be allowed to persist; moreover, this reduction in sales has actually been intentional and beneficial. WH Smith is today a focused business with a debt-free balance sheet, a net cash position of $72 million, sound working capital management, and more than 2.8 times coverage of its fixed costs. And the company has potential for even greater cash generation and shareholder returns going forward: it has inflation-adjusted, average owner earnings of $109 million per annum over the past five years, pretax earnings of $132 per square foot in its expanding Travel segment, a 4.1% dividend yield, and a record of productive share repurchases.
For these reasons, I am making an investment in WH Smith with the expectation of protecting principal and achieving a modest profit.