Source: Sharecast
WH Smith confirmed earlier that it was looking at potential strategic options for its high street stores, including a possible sale of the "profitable and cash-generative" unit after media speculation over the weekend.
RBC said that such a move would allow management to focus on the more attractive travel business, which accounts for 85% of trading profit.
RBC noted that in the 10 years prior to the pandemic, WH Smith managed to improve its EBIT margin by around 500 basis points, despite seeing its sales almost halve in that time. This was due mainly to a successful shift towards higher margin categories like stationery, and also due to multi-year cost savings, the bank said.
However, since the pandemic, its profitability has taken a step down.
"WH Smith continues to work on optimising its space, e.g. with its recent partnership with Toys R Us, but we think the outlook for High Street looks challenging given pressure on footfall," RBC said. "As such, we would view a potential sale as a positive as it would remove a key overhang on the shares."
RBC said that in the travel segment, WH Smith should continue to benefit from a strong unit pipeline in captive markets and from its strong category mix management and logistics expertise.
"In the UK it has a strong market position across its three major channels - Air, Hospitals and Rail, while in the US the tender environment remains active and we expect WH Smith to improve on its current circa 13% market share in the Travel Essentials segment," it noted.
"For Rest of World we await a recovery in passenger numbers in Asia, and its lower operating margin reflects the need for upfront infrastructure costs while it establishes brand scale."
RBC said WH Smith should also continue to show attractive cash returns, e.g. a £50m annual share buyback, while keeping its net debt/EBITDA in a 0.75-1.25x target range.
It also pointed to potential for further M&A in the sector.
"We see scope for further M&A in Travel Retail given the potential for stronger landlord relationships and cost savings e.g. in procurement," RBC said.
"Dufry and Autogrill successfully executed on their merger and synergies which have recently led to improved cash returns from combined company Avolta, and we estimate circa 25% of US tenders in the past year have included a hybrid element (duty free and duty paid)."
In the case of WH Smith, RBC said it sees potential for it to push further into food to go, including in the key US market, which it thinks is currently underserved in this area.
RBC rates WH Smith at ‘outperform’ with a 1,400p price target.