Shares: Profit in store after overhaul at the top: As interest rates fall, three large retail chains are set to cash in on the impending revival of consumer demand

AS UK interest rates go into free fall, thoughts are again turning to recovery potential in store shares. This time the optimists could be right. If they are, the timing could be perfect for shares in my three recovery selections, Asda at 42p, Storehouse at 150p and Sears at 90p.

Each has a new management team at the top taking drastic steps to improve the profitability of the business. If they find themselves doing this against a background of rising consumer spending, results could be dramatic. Another stores group, Next, has shown what can be achieved, with nearly a 10-fold rise in the share price from its low point.

A measure of the potential comes from the valuation of the businesses. For instance, the food retailer Asda is capitalised at pounds 892m, against turnover last year of nearly pounds 4.5bn. In contrast, the sector leader, J Sainsbury, itself fairly modestly rated by investors given the growth record, is valued at nearly 10 times as much, with double the sales.

Nobody supposes that Asda is ever going to achieve Sainsbury-style profit margins, but a valuation equivalent to half the turnover looks achievable, and would imply a share price of pounds 1 even without allowing for turnover growth.

There has already been some recovery at Asda from a low point of 22.5p, but that largely reflects a mixture of confidence in the new management under Archie Norman and belief that the group is going to survive. That represents quite a change. Under the previous management the group had turned a cash surplus of pounds 1bn into borrowings of pounds 1bn in just five years, aided by such disastrous deals as the pounds 300m purchase of stores from Gateway.

The balance sheet has been strengthened by a rescue rights issue in October last year, and more recently by the sale of the stake in MFI and two properties to Sainsbury and Argyll for an impressive price. Borrowings should now be comfortably below 50 per cent of shareholders' funds, though most are on fixed-term rates, so there will not be an immediate boost from lower sterling interest rates.

Archie Norman was the highly regarded finance director of Kingfisher, and participated in the group's remarkable recovery from a low point in 1982 in many ways worse than the position Asda is starting from. The latter, after all, made operating profits of pounds 180m last year, and is expected to make pre-tax profits of around pounds 100m this year and perhaps pounds 130m for the year to April 1994.

Mr Norman's strategy is to look at everything the group is doing to cut costs and raise efficiency while concentrating on growing by offering low prices allied to a wide choice of staples, fresh foods and other high-margin items. He claims Asda is the fastest-changing retailer in Britain, and outside observers say the crucial like-for-like sales figure is growing faster than the industry average. Interim figures are to be reported a month early, in December, which is a good sign. The rewards for top management and shareholders will be substantial if the three-year recovery programme delivers.

Storehouse's problem was not that it might go bust, but that it seemed to have lost its focus and become a conglomeration of high-street businesses, none of them performing well. Again, the catalyst for change has been new management, with David Dworkin becoming chief executive.

Mr Dworkin is expected to concentrate the group on the two mass-market clothing operations, BhS and Mothercare, with Habitat and Richards being sold. The Habitat sale will remove a lossmaker and bring some cash into the group. Meanwhile the BhS business is believed to be trading well.

Analysts have been revising earlier expectations of a significant first-half loss and now expect the group to have roughly broken even in the first half, due to be reported next month. Full-year expectations are for profits of pounds 40m, against pounds 15.8m last year and the record pounds 115m achieved in 1988. That should drop the price-earnings ratio to 23, with a further fall to 15 expected in 1993-94.

Sears is at an earlier stage of recovery, but investors are impressed that under the new chief executive, Liam Strong, the group is at last biting the bullet, by promising a massive closure programme on its high- street shoe shops. Common sense suggests a group making nothing from selling 20 per cent of the nation's shoes must have enormous recovery scope.

Sales were around pounds 2bn last year, and the group made profits of pounds 273m in 1989. A return to anywhere near that sort of performance, admittedly not in prospect in the short term, would transform the share price.

(Photograph omitted)