CIT better geared but some concerns remain

CI TRADERS, the Channel Island retail and leisure company that is listed on the London Aim market, unveiled its full year results to 28 January at the end of last month. Turnover increased by 11%, but profit before tax lagged behind with a rise of only 3.4%.

Earnings per share were broadly flat for the year and gearing continued to rise, so the company was unable to raise the dividend materially or in real terms, although it still offers an attractive yield of 6% gross.

The company was very active on a corporate level during the year as it acquired the CI Safeway stores, disposed of its UK restaurants and a large investment property, tackled a bid approach from a private equity firm and reorganised its management structure.

The acquisition of Safeway caused particular problems when demand fell away as customers boycotted the stores and the supply chain unravelled.

The underlying results are therefore harder to interpret because there is a morass of exceptional items relating to acquisitions, disposals, asset write-offs and pension adjustments.

CIT has four main businesses that are organised as retail, hospitality, manufacturing and distribution and property units.

Retail produces 57% of the company's turnover, while manufacturing and distribution generates 32% and hospitality 11%.

The Channel Islands are its core market and produced 85% of the year's turnover and hold 96% of the company's assets.

CIT is therefore a conglomerate with activities in different sectors of the economy, but it is clearly dependent on the continued financial health of the Channel Islands.

Unfortunately, CIT has experienced poor trading conditions and greater competition in its principal markets, which have caused its financial underperformance.

Although turnover rose by 11%, gross profit fell by 5% because its sales mix was less profitable, while weak demand and intense competition undermined its pricing power and prevented the company from raising its prices to recover higher costs.

There was a fall in profits at the hospitality division because Guernsey pubs and hotels struggled, particularly the St Pierre Park, which was earmarked for the new Guernsey casino.

CIT blames declining visitor numbers, fewer construction workers, higher excise duty and increasing domestic consumption of alcohol for the lower profits at its bars, pubs and restaurants.

Trading profits also declined at the manufacturing and distribution division, which wholesales food and beverages in the Channel Islands and manages a bottling operation in France and a UK warehousing and storage business.

Turnover fell sharply in the Channel Islands as higher excise duty encouraged the private importation of alcohol and tobacco and the fall in sales at Safeway had the same effect on manufacturing and distribution. Fierce competition from low-cost, large-scale producers in France hindered the bottling operation, while the UK business was unprofitable prior to its acquisition during the year.

The retail division includes the grocery and fuel retail arm, Le Riches, and the franchise and non-food business, Riche's Marques. It also experienced falling profits in spite of a strong performance from the Marks & Spencer Jersey franchise within Riche's Marques, as Le Riche's strove to integrate Safeway and competition strengthened in a stagnant fuel market.

The picture is therefore bleak in the company's three trading divisions as they labour to contend with general market issues such as slowing demand and stronger competition and specific issues such as the Safeway acquisition and the St Pierre Park.

The company declares that its future is the large, valuable property division, which generates little return now, but promises to deliver excellent profits in future and underpins CIT's market value.

There does indeed seem to be significant uncrystallised value in the division.

At Admiral Park alone, the company is selling the B&Q superstore and has major plans for further developments on the site, including more than 80 flats worth more than £30m. and another retail and leisure complex.

The former Guernsey Brewery site could become a hotel, the former Ann St Brewery location in St Helier may be converted into a car park and an old warehouse next to a Checkers store in Jersey should become a new Checkers superstore.

The potential for the company is therefore visible, but shareholders have reason to be cautious. They may apply a discount because the company is a conglomerate and is very dependent on the Channel Islands, particularly its commercial property market in the future, and there is uncertainty over the impact of the future taxation strategy on corporate activity. Moreover, shareholders may think that the promise of the property portfolio is a case of 'jam tomorrow' and the merger of Ann Street and Le Riche's in the past has not delivered the returns they were expecting, with profits stagnating since 2002.

The fact that the other divisions are not performing well now, while they expect strong profits in the future from the property division, does not help matters.

Finally, the other serious problem hanging over the company is its soaring level of debt and therefore high financial risk.

CIT has recognised that it is imprudent to have such high gearing given its current level of operating profitability and in spite of its large freehold property portfolio, so it intends to sell some of its investment and development properties and to refinance the business in order to reduce its borrowings.

Interest payments and gearing levels have been rising quickly, leading to deteriorating interest cover and the near-exhaustion of borrowing facilities. The company's operating cashflow has stagnated, which means that it is beginning to struggle to finance its growing interest payments, its commitment to raise dividends and its large capital expenditure programme.

The company is vulnerable to an economic downturn and has little flexibility to pursue the opportunities it has available, given the current state of its markets and its level of borrowings, without disposing of some assets or increasing its gearing.

It has wisely chosen the former, but the future is still uncertain.

* Comments to rich@hemans.net. Richard Hemans is a chartered accountant who works on a freelance basis.