Merchant and its Ode to Cologne

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The Independent Online
In The 1980s niche retailers like Body Shop were all the rage. Even now, after many ups and downs, the concept of a retailer rolling out a successful niche format around the country still has the power to grip investor imaginations. Merchant Retail, at 20p, a company still convalescing after years battling heavy debts, presently makes most of its money from less exciting provincial department stores. But it has a potential jewel in the crown in the form of its fledgling chain of specialist fragrance outlets, which trade under The Perfume Shop banner. Last year the fragrance side made just over a fifth of group trading profits of pounds 2.6m but could easily grow to become the main profit centre over the next few years.

The fact that the group is around and healthy is something of a miracle after things went badly wrong in the early 1990s recession. Built up by acquisition in the 1970s and 1980s from a shell known as Single Group, a big step came in 1980 with the acquisition of a food retailing business, Normans, which in 1984 also became the new name of the business. Further deals followed, including the acquisition of the Joplings group of department stores in 1987 and yet a further name change, to Merchant Retail Group, in 1990. But when recession hit, the heavily borrowed business's debts ballooned to more than pounds 20m - well ahead of shareholders' funds, leaving the group at the mercy of its bankers.

The history of the 1990s, under a new management team led by managing director David Wallis and deputy managing director Philip Newton, is one of reorganisation and attempts to pay down the debt. The breakthrough finally came late last year with the sale, in bits, of the previously unsellable Normans business for pounds 16m - pounds 2.5m less than book value.

The Perfume Shop sells fragrances partly sourced directly from star names such as Chanel and Calvin Klein and partly bought on the parallel market. That market, worth over pounds 2bn, is for branded articles supplied by sources such as duty free shops, that have over-ordered.

Mr Newton says the prime target is women who are intimidated by the "goddesses in white" selling perfumes from department store counters.

So far the strategy is working well. It needed to: when the format was launched in 1992 it had to be immediately profitable because the group balance sheet was so weak. Since then the chain has grown from nothing to 28 stores with branches as far afield as Dundee, Belfast and Bristol. Profits since 1993 have grown from pounds 70,000 to pounds 100,000, pounds 303,000 and pounds 566,000 with sales climbing from pounds 9.5m for 1995 to last year's pounds 14m.

The ultimate target for the chain is around 100 outlets with numbers expected to reach 33 by March 1997. It hopes to grow by 10 to 12 outlets the following year and perhaps 20 outlets in 1998-99. A restraining factor is that locations have to be carefully selected; some stores have already failed and been closed. High streets do not work. The ideal location is a busy mall permitting an open frontage to encourage impulse buyers. As sales grow, margins should improve from last year's 3 per cent to perhaps 5 per cent in two years - by which time the chain could have doubled in size - and ultimately to nearer 10 per cent.

Based on those calculations, 100 stores could generate sales of pounds 50m and profits between pounds 4m and pounds 5m. That, though, is some way into the future. Current year projections are for group profits to reach around pounds l.5m, making for a prospective p/e ratio of 17 times. A healthy further improvement is also likely in 1997-98 as sales and profits continue to grow while last year's hefty pounds 1m-plus interest bill continues to shrink. The shares remain a speculative buy but, with net asset backing of 20p a share, the downside looks limited. If all goes well, the price could rise several fold by the end of the decade.