Sweep up profits at Carpetright

Still some puff left in BAT; Time to retire McCarthy & Stone

There was a nasty stain on the shag pile yesterday as Carpetright issued what was basically a profits warning. Britain's largest carpet retailer argued with this description but with a trading update which warned of lower profits in the core UK business as well as higher-than-expected losses in the new European venture, it was hard to come to any other conclusion.

That the shares only closed 6.5p lower at 586p was due to some skilful damage limitation by Lord Harris of Peckham, the chairman of Carpetright. But analysts still chopped 7 per cent of current year profit forecasts.

No matter which way you look at it, yesterday's update looked a bit frayed at the edges. Trading has weakened in the UK with like-for-like sales in the 25 weeks to 26 April down by 0.4 per cent on last year.

Carpetright says this impact will be partially offset by better margins, which at the gross level are up by 2.5 percentage points on last year. Even so the net result is that operating profits for the full year will be £57m rather than £60m. Meanwhile the fledgling European business in the Netherlands and Belgium will make losses of about £4m rather than the £1.5m previously expected. A restructuring is being undertaken with the European head office being closed and more price promotions being introduced.

Carpetright is a solid business with a market-leading position and a well-covered dividend. But the signs are that this is a mature business whose core UK business has lost a bit of momentum while the higher-growth Continental European operation struggles to make the headway hoped for.

UK like-for-like sales are forecast to be flat and the worry is that Carpetright cannot continue increasing margins forever. It is open to question where the share price would be if the Saudi group Olayan had not been building up a 12 per cent stake.

On a price-earnings ratio of 11 compared with 7 at DFS the shares do not look cheap. After a strong run it could be worth taking profits.

Still some puff left in BAT

As the only UK cigarette maker with operations in the US, British American Tobacco is the only tobacco stock with exposure to the potentially deadly outbreak of litigationitus that has left industry giants such as Altria (formerly Philip Morris) and RJ Reynolds coughing and spluttering.

BAT is also the only UK tobacco group to have suffered from price competition in the US. To that end, the 50 per cent fall in first-quarter profits at Brown & Williamson, the group's US outfit, came as little surprise.

Both of these factors help explain why BAT's shares trade at a 20 per cent discount to the rest of the European tobacco sector. Neither, however, unduly worry the company, which yesterday said its US business was "taking in water, but not sinking". Nor do they worry investors, who marked the shares 4.5p higher at 600p. Litigation risks have always dogged BAT, but have not stopped it outperforming practically every other London-listed company in recent months.

BAT throws off enough cash to allow it to run a share buy-back programme while combing the world for possible acquisitions. It is bidding for the Italian tobacco monopoly and has an eye on possible spoils in the US. Both moves should help mitigate the negative earnings effect from the weakness of the US dollar and the competitive conditions in the US.

BAT reported first-quarter pre-tax profits of £464m, compared with £463m in the first quarter of 2002. Operating profits fell from £523m to £515m. Its top four brands – Lucky Strike, Kent, Dunhill and Pall Mall – continued their strong run, with volumes up by 15 per cent.

Analysts expect the lack of earnings momentum to hold the stock back over the next few months, but BAT's long-term prospects are as healthy as anything linked to a cigarette company gets. What's more, the shares yield a tasty 7 per cent. Buy on any weakness.

Time to retire McCarthy & Stone

McCarthy & Stone is one of those companies which is definitely on the right side of Britain's demographic time bomb. It is the biggest builder of retirement flats and other sheltered housing, with 65 per cent of the market. Its margins are a massive 40 per cent and it has plenty of land in the pipeline.

Half-year profits reported yesterday were way ahead of market expectations, rising 80 per cent to £39.7m. The number of unit sales rose 34 per cent to 831, with the average price up 19 per cent to £122,900.

So why did the stock drift 8.5p lower to 366.5p yesterday? The answer is a combination of profit taking – the shares had been trading at a five-year high – and comments about prospects. While the results were clearly excellent, McCarthy & Stone said it anticipated some softening of the market. It said this was most apparent in the central London market, though the area within the M25 only accounts for 4 per cent of the group's sales.

This offers protection but with the perceived wisdom being that what happens in London first has a ripple effect on the rest of the country later, this looks a worrying trend. There was also a note about "build cost pressures" particularly in labour and increased regulation such as the aggregates tax and landfill duties. Take profits.