Questor: Strong foundations prime this DIY giant for growth

Share tip: improved consumer purchasing power is set to invigorate company’s bottom line

Kingfisher’s deteriorating financial performance should come as no surprise. The home improvement retailer, which owns Screwfix and B&Q, has experienced a 38pc decline in profits over the past two years amid an incredibly weak operating environment.
Indeed trading conditions for retailers that sell discretionary items have been hugely challenging. Inflation surged to multi-decade highs causing a cost-of-living crisis which prompted consumers to delay or even cancel unnecessary spending, particularly on home improvements.
The company’s latest quarterly trading update further evidenced a weak consumer environment. Although the firm is still on track to meet previous financial guidance for the full year, like-for-like sales declined by 0.9pc in the first quarter of the year. 
As a result of its downbeat financial performance, investors in the firm have experienced highly disappointing returns. Shares in Kingfisher have risen by just 3pc since this column’s original tip in September 2020. This represents a vast 26 percentage point underperformance of the FTSE 100 over the same period.
Now though, the company is set to gradually experience a considerable improvement in operating conditions. Consumers are already feeling better off, with average pay in the UK rising at an above-inflation rate for the past 15 months. This increase in purchasing power should prompt a gradual rise in demand for discretionary items sold by Kingfisher.
The UK economy is about to benefit from a high dose of monetary policy easing. It will take many months for interest rate cuts to deliver their full impact due to the existence of time lags. However they are set to prompt lower mortgage costs and a more buoyant economy that reduces the unemployment rate, which should lead to an improving financial outlook for the company.
A looser monetary policy is already being implemented in the Eurozone. The European Central Bank cut interest rates in June and it is likely to adopt an increasingly dovish stance, with inflation now just 50 basis points above its 2pc target.
This bodes well for Kingfisher’s outlook, since roughly 32pc of its sales are generated in France. This compares with a figure of 50pc from the UK. And while political risk may remain somewhat elevated, the company’s long-term prospects are nevertheless upbeat.
In the meantime, the firm’s sound financial position means it can overcome any additional economic uncertainty. It has maintained a solid balance sheet despite a tough retail environment, with net gearing currently amounting to just 32pc. Net interest cover in its most recent financial year was six. This figure is highly impressive amid declining profitability and is likely to expand substantially over the coming years.
Furthermore, the firm reported in its latest quarterly update that it continues to make productivity gains, which should help to offset weak sales growth. And success in gaining market share equates to a stronger market position through which to capitalise on an improving economic outlook.
Investors appear to have more than adequately factored in the potential for any short-term economic and geopolitical uncertainty. The company’s shares currently trade on a price-to-earnings ratio of just 12.7, which suggests they offer a wide margin of safety and scope for significant capital growth.
A low share price also means the company’s ambitious share buyback programme is highly logical. Having completed share buybacks totalling £600m, it is now engaged in a further programme that will return £300m of excess capital to shareholders. This should support its share price in the short run and offer an additional catalyst for capital growth over the medium term.
Meanwhile, a dividend yield of 4.5pc will supplement capital returns. Dividends per share flatlined over the past two years. A dividend payout ratio of 57pc suggests that shareholder payments could rise at a brisk pace as profits grow amid interest rate cuts and an improving consumer outlook.
With Kingfisher holding a strong market position and a solid balance sheet, it is well placed to capitalise on rising demand for its products. Its low valuation suggests investors have not priced in the prospect of an improved financial performance.
While the stock has proved to be a thorough disappointment since our original tip nearly four years ago, it remains a worthwhile long-term investment.
Questor says: buy
Ticker: KGF
Share price: 277.1
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