Christmas 2004 was officially a write-off for most retailers. Shoppers went cold turkey on shopping and Government figures last week showed that the high street endured its worst December since 1961. It is tempting to write off the entire sector as an investment for 2005, too. But don't.
Of the very few Christmas crackers, Monsoon, Body Shop, Dixons and HMV stood out. Elsewhere, WH Smith and Game Group's decision to focus on the bottom, rather than the top, line paid off.
The highest profile loser was Marks & Spencer, which saw its underlying sales plummet 5.6 per cent. Even Next and Argos, part of GUS, disappointed their huge fan clubs, with slower-than-expected growth.
So far, 2005 has already started badly for both Allders and Pilot, an unquoted clothing chain: both have collapsed into administration. With house prices falling, consumer debt rising and no sign that interest rates will fall from 4.75 per cent, the rest of the year looks only set to get trickier.
Consumer belt tightening means this year calls for a change of investment strategy. Stop obsessing with sales and try not to get too bogged down with valuations. It will take greater things to get share prices moving this year. Think corporate action.
Fresh speculation that Marks & Spencer and J Sainsbury could be bid targets meant the general retail sector actually outperformed the FTSE last week, in spite of all the profit warnings. (Our view is that a bid for either is highly unlikely, so neither will make it into this year's portfolio.)
The first of this year's high risk, high reward choices is French Connection. It paid the price for poor autumn ranges with a profit warning and its shares lost half their value. The odds are that either Stephen Marks, its founder and chairman, will sort out the collections in time for summer, or he will take the group private. Either way, the stock, trading now on a forward price/earnings ratio of 10.4 times, looks cheap.
Another candidate for possible predator action is MFI. The kitchen group has a hidden gem in Howdens, its joinery arm, and speculation abounds that at least one part of the company will attract a bid. Meanwhile, at Wyevale Garden Centres, it is the presence of Laxey Partners, a notoriously aggressive investment company, that offers most hope for its shares. If the group can't build on its Christmas sales foundations, its active investor is likely to force it to. Using a similar logic, Matalan is also worth holding.
Less high-risk is GUS. The Argos retail-to-Experian financial services conglomerate is reviewing its strategic options and the smart money is that shareholders will be left holding stock in two separate companies by this time next year. On a forward p/e of 13.4 times there is undoubtedly still hidden value to go for.
A focused Misys could be one to watch
Health services will be so much more efficient when patients' medical records are kept on computer rather than stored in great folders stuffed with notes. Misys is one software firm whose products include electronic health records. In the UK, it is just setting up its systems at a big hospital in the north of England. But its focus is the US, where it has won market share. The Federal government wants all records on computer in a decade, up from 15 per cent so far, so the opportunity is vast.
The picture is duller in other areas of the company's business. In particular, the division which supplies software to banks, both in the City and on the high street, continues to struggle. Financial institutions began spending on IT again last year, but it doesn't look as if Misys has been in the vanguard of the recovery. Underlying sales growth in this area in the six months to 30 November was just 2 per cent, but order growth was faster and this ought to feed through in the second half of the financial year.
Profits are still going backwards at Sesame, its network for independent financial advisers. Yet here, too, there is reason for optimism. Changes to the way the industry is regulated are creating a class of IFA selling a limited number of company's products, and Sesame has new systems that can support them in dealing with regulatory compliance. The division will be spun off, or sold entirely or in part, probably this year. That might be a catalyst for improving City sentiment towards the stock, which sits at a too-big discount to the rest of the software sector.
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