Business Analysis: Boots confident it has found the right prescription

High street giant posts 25% fall in underlying profits as it focuses on core chemist chain
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The Independent Online

Boots unveiled a sharp drop in interim profits yesterday - but that did not prevent the group's top brass from insisting it could withstand mounting pressure on the high street.

Richard Baker, who took over as the chief executive 12 months ago, declared the group was on track with its attempt to re-establish its retailing authority, pointing to rising sales, market share and customer numbers as evidence that Boots was off the sick list.

The company may be a legacy retailer in the vein of a J Sainsbury or a WH Smith, but aside from a similar length shelf life, the businesses are as different as, well, two brands of shampoo. Or that was Mr Baker's view yesterday when striving to justify his optimism in Boots' future. "Look at our sales growth. It is very different to everyone else because we have strong brands in growing markets," he said.

Although Boots disappointed some City scribes, with a 26 per cent fall in pre-exceptional interim profits before tax to £199m, even the more bearish analysts applauded the group's headway in driving sales from its core chemist chain. Underlying sales across its retail estate rose 3.8 per cent during the period, despite price deflation of 4.9 per cent.

Now that Mr Baker has washed his hands of such distractions as dentistry and laser eye surgery, instead knuckling down to the less headline-grabbing business of lowering prices and revamping the group's shops, Boots is giving its customers more reason to shop there than just the stores' handy locations.

Matthew McEachran, a retail analyst at Investec Securities, said: "It's totally unfair to compare Boots with the likes of Sainsbury's and Marks & Spencer." For one, he adds, "you would struggle to find another retailer with as many reasons to visit as Boots". The group has "multiple" draws, from its over-the-counter healthcare business and trained pharmacists, to its premium cosmetics ranges and babycare know-how. "That's why it has such strong footfall - more than 20 million customers per week."

Boots has numerous own brands, including the UK's biggest premium cosmetics brand in No 7, Soltan suncream and, most recently, its Basics ranges of entry-price cotton wool and the like. Plus Mr Baker points out that all of the group's markets are growing.

Mr McEachran added: "For Boots, the issue is more about getting the offer right, managing the margins and sustaining the sales growth. Once it's got to that position, there will be a valuable business that has sustainable growth".

Maureen Hinton, at Verdict, the consultancy, said that unlike some other legacy retailers, "Boots hasn't lost its way. It can be different from the grocers because its offer is so wide." David Stoddard, at Teather & Greenwood, said: "As a sharper operation, there will be a place for Boots. Richard Baker has earned the benefit of the doubt so far."

For Mr Baker, improving Boots' financial performance boils down to three key "musts": making the business more modern, more competitive and more efficient. "It's early in the process but the customer is responding. Sales growth has continued against disruption and deflation. There is plenty of opportunity but there are few quick fixes. Retail change takes time and this will be no exception," he said.

In terms of modernising the business, he has extended store trading hours - from 8am to 8pm - to fit in with its customers' busy working lives and opened an extra 200 sites on Sundays. He has also invested heavily in new tills, cutting queuing times by one-third, and spruced up 250 of its biggest stores. Its top-50 stores now have sparkling new beauty halls, better pharmacies and bigger ranges: its flagship London branch in High Street Kensington now sells Clarins and Clinique make-up products. The group is also chasing growth from the illustrious out-of-town retailing market. It has 96 "edge-of-town" stores, up from 69 five years ago.

To tackle intense competition, from supermarket giants such as Tesco and Asda to high street discounters, Mr Baker has spent tens of millions of pounds on lowering prices. Boots' "Lower prices you'll love" campaign has targeted its three most price conscious areas: toiletries, over-the-counter medicines and baby products. During the period prices across these three categories fell by 9 per cent, but total sales grew 3.6 per cent and volumes soared by 8.7 per cent. The price of toiletries alone has plunged by 12 per cent - or up to 30 per cent on some products.

This massive price investment was behind the group's previously flagged 180-basis point drop in gross margin at Boots The Chemist. In order for it to hit its projected full-year decline of just 110 basis points, it is banking on a decrease of just 50 basis points during its second half. Howard Dodd, the finance director, said: "The small shortfall in first-half profit means the second half is key, but our guidance for the full year remains unchanged."

Lastly, to increase the group's efficiency, Mr Baker is taking out costs and head office jobs, while tackling that retailing bogey that Sainsbury's recently proved makes or breaks a business: its supply chain. So far, more than 1,600 jobs have gone from its headquarters in Nottingham and the manufacturing business, with another 500 posts scheduled to go in the second half. The group hopes to save £93m this year and £132m next, but to date has mainly racked up costs, not savings.

In an effort to avoid repeating Sainsbury's well publicised distribution woes, Mr Baker has literally stockpiled to ensure there are no gaps on shelves during the all-important Christmas period. This is behind a massive increase in the group's working capital, which includes an additional £105m more stock in the business. All of the group's 1,434 stores - even the tiniest high street sites - are already receiving deliveries six times a week. In 70 per cent of instances, stock is being delivered by the single item, rather than cases of hard-to-shift beauty products.

Meanwhile, Boots' healthcare arm plods on, growing sales by 1 per cent during the period to £244m. Mr Baker insists the company would not spin off the business, despite suggestions from some analysts that doing so would enable the group to crystallise hidden value of up to £1bn. And Mr Baker actually sees positives for Boots from the recent partial deregulation of the pharmacy market, citing the potential to put pharmacy counters in up to 50 more stores.

"We are very honest. We have got a big job on our hands but we are delivering our plans on track. That's the message today," Mr Baker said.

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