WH Smith blames Sars and fall in CD sales for profits slump

WH Smith shares fell sharply yesterday after the high street retailer issued a profits warning blaming a "highly competitive sales environment", the Sars virus and the recent spell of hot weather.

The warning means the chief executive designate Kate Swann will face a tougher than expected challenge when she joins the company later this year from GUS.

Current chief executive, Richard Handover, who will move up to the chairman role when Ms Swann arrives, said the entertainment section of Smiths had borne the brunt of the pressure. He blamed the malaise of the music industry and a poor schedule of album releases but analysts said other factors were also at work.

The major supermarkets such as Tesco and Asda have been cutting the price of chart CDs to less than £10, damaging Smith's market share. The decision by Amazon.com to make permanent its free delivery offer for orders over £39 is also likely to have had an impact.

Smith's gross margins will fall by around 0.6 per cent, primarily as a result of margin decline in the entertainment division. Profits in the UK retail business will now be below expectations and analysts have cut their full-year profit forecasts from about £110m to £100m. The shares fell 7 per cent to 351.25p.

Mr Handover admitted that a profits warning is not quite the farewell he would have liked as chief executive. He said: "Of course it's not. We'd all like things to work out in a fairy tale way. But life is what it is and you just deal with it."

On the entertainment business, Mr Handover said: "We had a double whammy of much lower sales, particularly in music, and margins being under huge pressure as the market goes into massive discounting".

Credit Suisse First Boston analyst Tony Shiret said he thought entertainment sales were down an underlying 7 per cent in the second half with CD sales down in double digits.

Shares in other music retailers HMV and Woolworths slipped on the news.

Asked how WH Smith planned to combat the continued threat from the supermarkets to its entertainment business, Mr Handover said the stores would devote less space to this section with more made available to books and stationery which have performed well.

The hot weather has caused problems for many retailers who have said it was too hot to shop in August. The impact of the Iraqi war and Sars on airport passenger numbers have hit Smith's UK travel retail business which has stores in airports and railways stations.

Smith's said it was "continuing to review all its options" relating to its US travel business and will update the market in the next few weeks. This business includes stores in American airports and hotels and has been hit hard by 11 September, Sars and ongoing terrorist threats. Closure or sale are the most likely outcomes.

Kate Swann, who was previously head of the GUS-owned Argos chain, is under contract with GUS until the end of the year. Smith's is hoping she will be able to join sooner but her start date has yet been confirmed.

WH Smith has been the subject of bid speculation as it has strong cash generative businesses such as the news distribution operation. However, Mr Handover said he had received no approaches. He will become chairman when Martin Taylor retires.