Dixons on the dock


Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Little more than a quarter of the year has passed, yet Dixons has already issued two profits warnings and the electrical retailer's share price has dropped some 40% to around 12p - only a couple of pence above its 2008 all-time low. Equity investors are running scared and, on the face of it, they may have some reason to do so.

But what do investors in the company's bonds think? After all, they are analysing the same business and the same cashflows. Granted, they have to consider slightly different risk appetite but ultimately it is the business that dominates how cash is generated and it is cash that both pays bond investors and generates profits for equity investors.

And bond investors have a different view of Dixons’ business. In early 2009, when asset markets were at their worst, the group’s bonds yielded more than 20% but that has now fallen to 12%. This is the bond market saying Dixons is in better shape today than it was two years ago.

This is an interesting difference of opinion as the bond market is supposed to be able to appraise a company's safety more accurately than they equity market. The bond market's job is to look at the risk of capital loss and, on that basis; it is saying Dixons should be all right.

That is not to say the company is risk free – as a bond yield of 12% would indicate, bond holders are not being complacent - but Dixons is the number-one electrical retailer in Europe. It has a very good Nordic business and a large online operation, it is closing its loss-making Spanish division, it has completed a major store refurbishment programme and it is doing a sale and leaseback deal that should help improve liquidity.

If bond holders are right to believe the business is in much better shape than two years ago, what could the equity ultimately be worth? If management targets can be believed, Dixons should be able to generate some 5p of profits per share, which would indicate a share price of 50p. On the current share price, that represents some 300% upside.

Obviously there is a chance something could go amiss, or the bond market is wrong to be more relaxed than two years ago. However, bond investors are always looking for a margin of safety and thus calculating the chances they could loose their money - and we do exactly the same

Despite those two profits warnings, Dixons actually expects its 2011 profits to be flat on last year. So it is not that profits are forecast to be down that is the issue for equity investors, it is that the expected growth in profits has reduced. For the equity market - which believes a company must grow profits every year - that is a cardinal sin. For value investors, that could be viewed as a window of opportunity.



Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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