Nevertheless, Sir Simon Hornby, chairman, urged the Chancellor not to devalue sterling, arguing that an increase in interest rates was preferable and would not do much harm to already sluggish retail sales.
Do It All, Smith's 50/50 DIY stores joint venture with Boots, slipped to an estimated loss after interest payments of pounds 9.8m in the year to 30 May from profits the previous year of more than pounds 20.
It was hit by blanket discounting of as much as 25 per cent by competitors like Texas Homecare, owned by Ladbroke, and Kingfisher's B&Q. Sir Malcolm Field, Smith's chief executive, described the price-cutting as 'insanity'.
'Brand loyalty has gone at the moment. It's about price. You have to join in, sadly, otherwise you lose market share.' However, there were signs that the blanket discounting was over, he said.
Sir Simon backed Chancellor Norman Lamont's stance on the pound: 'As long as he doesn't devalue I shall feel relatively secure.' An increase in interest rates to defend sterling 'would not make much difference to sales on the high street'.
He expected to see no recovery in the economy before the end of Smith's financial year next May.
Smith lifted pre-tax profits 27 per cent to pounds 112.7m, roughly in line with City expectations. Most of the improvement was due to the pounds 149m rights issue last May. A final dividend of 9.1p (8.5p) on the 'A' shares makes a total of 13.4p (12.5p).
Sales were up 8 per cent to pounds 2.13bn. The core WH Smith shops, the Our Price music stores, Waterstone's bookshops and the hotel and airport gift shops in the US all lifted like-for-like sales.
In Smith's second half, which took in Christmas, music was the most depressed product category. Sir Simon said compact disc prices for new releases were too high and blamed the large international publishers. Cassette prices were also 'creeping up and getting too high'.
Sir Bryan Carsberg, the Director-General of Fair Trading, has reopened an informal investigation into CD prices. Smith has about 28 per cent of the pre-recorded music market, recently buying a half-share in Richard Branson's Virgin Retail.
Videos, greetings cards and computer games recorded the highest sales increases.
On the distribution side, which accounts for almost half of Smith's sales, trading profits grew 19 per cent to pounds 29m. Newspaper and magazine distribution, which is the subject of a monopolies investigation announced last week, held its market share.
Office supplies lifted sales 10 per cent. The five subsidiary businesses will next month launch a joint own-brand, Niceday, yielding better buying terms.
The pre-tax profits included a pounds 9.2m credit ( pounds 11.2m) from the pension fund. John Napier, finance director, said he expected this credit, which caused some controversy last year, to drift down in future years.
Year-end borrowings were cut from pounds 232m to pounds 85m. The group wrote off pounds 67m of goodwill, including pounds 9.9m on the Virgin acquisition and pounds 29.9m on the acquisition of sundry US music shops.
Smith's share of the Do It All losses, after adding in rents and interest payments, was pounds 2.7m, compared with a pounds 10.4m profit last time.
Sir Simon insisted the group would persevere with Do It All: 'Good margins have been earned in the past and I'm confident they can be earned again . . when this mad price-cutting comes to an end. DIY is a colossal market, bigger than all our other markets put together.'
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