Shedding the flat-pack image

MFI Furniture yesterday displayed the benefits of its domination of the fitted kitchen and bedrooms market in the UK. With a market share three times that of its nearest rival, the group raised its turnover last year by 9 per cent to a record pounds 721m, despite a moribund housing market.

But those extra sales were won at some cost. Figures yesterday showed that the underlying pre-tax profits had slipped from pounds 68.2m to pounds 66.1m in the year to April 29, after stripping out the pounds 19.6m gain on the sale of a stake in Carpetright in the previous year's figures.

Despite its commanding market position, MFI found it impossible to pass on sharply higher costs in a highly competitive retailing environment.

As forewarned by the company in March, gross margins have been hammered in equal measure by rising raw material prices and a change in sales mix. Paper prices have soared by 40 per cent over the past 12 months, while chipboard is up 25 per cent.

On top of that, sales have moved away from products made in-house, like kitchens and bedrooms on which the company picks up a manufacturing margin, towards bought-in items, where only the retailing margin is available. The result of this switch has been to slash the gross margin from 55.9 per cent to 52.5 per cent last year.

The damage to the bottom line is underlined by the fact that MFI's figures were boosted by an additional pounds 1.8m from rental and other income -taking the total to pounds 13.4m - and an interest charge which was halved to pounds 2.6m.

The company claims that raw material price rises are now slowing, although it admits that paper has further to go, while it is moving into manufacturing its own electrical goods, pine furniture and composite sinks in an effort towards import substitution. But there are clearly long-term issues surrounding MFI which the company is only starting to address now that the huge debts of its management buy-out days are a thing of the past.

The ghosts of the poorly-fitting flat-pack image lives on at at the group, which the new HomeWorks store layout with its emphasis on pots and pans and the like needs to lay to rest.

There is also plainly a great deal to do with under-utilised store space, both in terms of selling area and warehousing. The management, led by chairman Derek Hunt, believes 1m out of the current 6m square feet of store space could be released, potentially bringing in an additional pounds 10m of rental income.

But patience may be wearing thin amongst shareholders who have seen the share price go exactly nowhere since the 1992 float.

BZW is looking for profits to dip further to pounds 55m this year, putting the shares at 115p, down 1.5p, on a prospective multiple of 18. That discounts a strong recovery in the housing market, which, with sales flat in the first weeks of the current year, shows no sign of appearing. Unattractive.