Can Russell kick start Boots back into retail's top ranks?

Back to basics strategy begins to pay off with rise in sales at core Chemists chain

Boots showed that the tentative improvement in its trading performance was continuing yesterday with first-half profits that were at the top end of City forecasts and improving sales at its core Boots the Chemists chain. However, the shares fell 17p to 581p on fears that the pace of sales growth might not be sustainable and that the group's margins would continue to be eroded by pricing pressure from the major supermarkets.

Reporting a 1.8 per cent rise in profits to £253.3m for the six months to September, Boots said like-for-like sales in the three months to September were up by 5.7 per cent on the previous year. However, margins fell by 0.8 percentage points as Boots added more aggressive price promotions.

Steve Russell, the chief executive, confirmed that the more upmarket Pure Beauty stores would not be rolled out as a standalone format but that elements of the offer would be introduced to the main Boots chain. The group also detailed a further £100m of cost-savings, including substantial job losses at the group's Nottingham head office as the retailer seeks to become more competitive. As part of its £170m store refurbishment programme Boots said it had updated 120 branches so far in London, with a further 45 added in October.

Mr Russell repeated his view that the company was now adopting a "back to basics" strategy that will see Boots place less emphasis on services such as dentistry, chiropody and Botox injections and more on getting its core stores right.

He said: "Our priority is to really consolidate and build the core business of Boots the Chemists. We are increasingly confident about the trends in top line sales and are investing £40m to turbo-charge the changes." He added that a review of the Wellbeing Services interests, which also include aromatherapy and laser eye treatments, would be announced in January. A decision on Boots' joint venture with J Sainsbury, in which Boots has taken over the health and beauty offer in nine Sainsbury's branches, will be taken by the end of the year.

But can Mr Russell really kick start the 150-year-old Boots engine, which has delivered a spluttering performance over the past few years? Or will Boots become "the next Marks & Spencer", a once great high street brand name that suddenly loses its way?

Analysts' views are mixed. Tony Shiret, at Credit Suisse First Boston, is a long-standing critic of the company and believes the Boots' attempts to move upmarket to escape the supermarket attacks were misguided. "What I would like to see is the company take a more realistic view of the competitive forces. When you've got such a big market share, you can't ignore the pricing pressures for ever." He pointed out that, like M&S, Boots had bought in Christmas stock aggressively as it had no significant store-opening programme to drive sales higher. Boots' inventories are £100m higher than last year if disposals are stripped out. Mr Shiret said that if Christmas sales proved disappointing Boots would be left discounting unsold stock.

Nick Bubb at SG Securities is more positive. "There has been lots of flitting around with peripheral things. But there is now a belated focus back on the basics of store design and ranges. It is not too late."

There is no doubt that the diversifications have shown limited success and the City has welcomed the scaling back of the group's ambitions beyond the core chain. Pure Beauty enjoys good sales but the store costs are so high that the company now sees a national rollout as uneconomic. The Well Being services division recorded a loss of £16m in the half year while the digital business, which includes a digital television channel and an internet site, cost Boots £11m in investment and write-downs in the six months. Even the move to open Boots stores overseas didn't work and Boots now operates a wholesaling approach whereby it stocks its goods in department stores. This is seen as a more viable model.

Belatedly, the company is focussing on getting the retail basics right. After problems with being out of stock in certain goods it is improving on shelf availability, which now stands at 97.9 per cent on key lines. The refurbishment plan is overdue, particularly in London where heavily-used stores had started to look shabby.

Costs are also coming down. The company's Nottingham head office had become so bloated that its property division alone had 100 staff at one point. Under Lord Blyth, the previous chairman, the 3000-acre site in Beeston had become like a huge army base. Even now it has 6,500 workers including 3,000 at the head office, with the rest in distribution, manufacturing and support functions. Mr Russell has changed 40 of the top 180 managers in the past 18 months. At board level there have been two appointments this year with Paul Bateman joining from Procter & Gamble as operations director and Howard Dodd coming in as finance director from AstraZeneca. With Ken Piggott retiring as managing director of Boots' retail operations, the number of "lifers" on the board has fallen sharply along with the average age.

The accounts are more transparent. Boots announced changes to the way it calculates its like-for-like sales yesterday and ended the practice of interest rate swaps on lease commitments, netting a £100m exceptional gain in the period.

The business has also slimmed down. With Halfords sold to CVC Capital Partners for £427m earlier this year and old duffers such as Do It All and Fads long gone, Boots has already done much of the pruning a break-up bidder might consider.

Boots Healthcare International, which manufactures brands such as Nurofen, Clearasil and Strepsils, could be sold off. However, the division, which recorded a slight dip in half-year profits to £35m after £10m of extra investment, is now being expanded to drive its best-selling brands further.

What else could be done? One analyst says Boots should stop trying to avoid the supermarkets and start trading its own business more aggressively. "They could take a certain number of basic goods and say they will match the food retailers on them and trade around that position," one said.

But the company has never seen its profits collapse in the way M&S's did after 1998. Boots has posted increased profits in each of the past three years. And its market share has remained rock solid since 1997. A final parallel with M&S is that no one wanted to see the grand old company struggle and there was almost a national sigh of relief when it started to recover. The same sentiments would apply to Boots. But the business needs to produce more evidence that its revised strategy is working before it gets the City, and its shoppers, truly onside.