A Lower Moat Rating for Kingfisher

Jaime Katz: We recently lowered our economic moat rating to none from narrow after reassessing Kingfisher's brand intangible assets and scale with the firm halfway through its five-year One Kingfisher restructuring plan. Our contention was supported by returns on invested capital that have remained depressed, dropping to 7% in 2018, below our 9% weighted average cost of capital. We attribute these unimpressive returns to a variety of macroeconomic factors, including fear over Brexit; management's decision to drastically reduce stock-keeping units over a short period, which has failed to enhance sales or profits; and a highly competitive environment in France and the U.K. This, in turn, also pushed us to rerate our stewardship rating to poor from standard.

Efforts to improve the business, however, have failed to stimulate demand in recent periods, and sales declines of 7% at Castorama and 3% at B&Q in 2018 waylaid the profit progress the company made in transformation efforts, leading to adjusted EPS that declined 9%. Furthermore, Kingfisher took its partially completed One Kingfisher plan off the table and inserted new goals that include growth in group sales along with higher gross margin, retail profit, and ROE (return on equity). Without any insight to the magnitude of these new goals, we are maintaining our five-year outlook, which includes, on average, flat sales growth, a gross margin that moves below 38% (versus a 37% average over the prior three years), and an ROE that rises to slightly above 8.0% (from a 7.7% average). These modest gains underlie our GBX 300 fair value, which we don't plan any material change to once we incorporate audited financial results into our model.