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The share price of WH Smith (LSE:SMWH), the FTSE travel retailer, plummeted on Thursday (21 August). Reason? It revealed it had identified an overstatement of “around £30m” in its expected headline trading profit in its North America division.
What’s going on?
The problem relates to the treatment of supplier income — incentives and discounts — that appear to have been recorded too early in the group’s accounts. Accounting standards require these to be reflected over a period of time rather than as one lump sum. Indeed, the group’s own financial statements explain how they should be treated: “These incomes are recognised as a deduction from cost of sales on an accruals basis as they are earned”.
Given the straightforward nature of the issue, this week’s reaction of investors isn’t a surprise. As the company itself admits: “The level of complexity and judgement is low in relation to establishing the accounting entries”.
A revised strategy
Shareholders will be bitterly disappointed as the group’s coming to the end of a period of reorganisation. I suspect they’ll have looked forward to a period of relative calm as the retailer streamlines its operations to focus exclusively on its shops at airports, railway stations and in hospitals.
In March, it announced the sale of its high street stores. Four months later, it disposed of funkypigeon.com, its online personalised greetings card business, to Card Factory. After costs, these transactions should generate £47m of sales proceeds.
Looking ahead
I suspect it will be a while before confidence is restored in the group’s management.
All eyes will be on the findings of the “independent and comprehensive” review that’s now underway. A further update will be provided in November. That’s when the group’s due to report its preliminary results for the year ended 31 August (FY25).
To me, WH Smith’s emphasis on travel sites and its exit from the high street makes sense. The problems experienced by retailers in our towns and cities are well documented.
By contrast, air and rail passenger numbers are expected to increase over the next decade. And as I found out earlier this month at one of its airport shops, the prices charged for basic food and drink items are far higher than elsewhere. I’m confident that the margins on products sold at its travel sites are much bigger than those earned previously from its high street shops.
Not for me
However, despite this, I don’t want to invest. The accounting error means it’s difficult to know how profitable the group really is. It’s now forecasting FY25 pre-tax earnings of £110m compared to the £157m predicted by analysts before this week’s announcement.
One benefit of the drop in the share price is that, based on amounts paid over the past 12 months, the stock’s yield is now 5.2%. The average for the FTSE 250 is 3.4%. Of course, there are no guarantees when it comes to dividends and, given the circumstances, there could be a cut. However, the accounting problem identified doesn’t call into question the existence of the supplier income only the timing of its recognition.
Another possible benefit is that the group’s current share buyback programme will go further than previously anticipated. However, due to the uncertainty, I don’t want to buy any of the group’s shares.
