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PPR Profits Seen Falling by Up to 50%

Analysts are giving Pinault-Printemps-Redoute mixed reviews as the French giant prepares to disclose first-half profits next Thursday.

PARIS — When France’s Pinault-Printemps-Redoute discloses first-half profits next Thursday, a year will have passed since the distribution conglomerate began a vast strategic realignment that steered it away from its once core business-to-business activities in favor of its higher margin retail and luxury divisions, including Italy’s Gucci Group.

Most analysts applaud the rapidity with which the shift has been executed and say PPR stands to gain in profitability and performance once consumer spending picks up in the now sluggish European retail and global luxury industries.

Still, analysts expect PPR’s pretax profit in the first half to decline by as much as 50 percent, mostly reflecting the deconsolidation of its credit and financial services arm late last year. First-half sales, reported in July, declined 7.8 percent to $13.25 billion, or 12.27 billion euros, from $14.37 billion, or 13.31 billion euros, last year. All figures are converted from the euro at current exchange rates.

“They’ll get through the next year and the strategy will be executed,” said Robert Miller, director of European research for retail at Dresdner Kleinwort Wassertein in London. “The new strategy was the right direction to take.”

PPR began remolding its profile at a moment when financial markets questioned how Gucci, which PPR gained control of in 1999 after a bitter takeover battle with LVMH Moët Hennessy Louis Vuitton, fit in to the group’s diversified interests, spanning from wood and electrical components to office supplies and an African trading company.

Additionally, PPR, controlled by French billionaire François Pinault, faced criticism that it had overpaid for Gucci — at more than $8 billion. Investors also pondered whether the group, strapped with some $6 billion in debt, would be able to meet an obligation in 2004 to buy all of the Gucci stock it doesn’t own at $101.50 a share.

But by incrementally buying clumps of Gucci stock on the open exchange, PPR has built its stake in the Italian giant to 66.65 percent from 53 percent a year ago. By yearend, PPR is expected to have increased its Gucci holdings to 70 percent, spending about $432 million, or 400 million euros, to reach that level.

Responding to criticism that Gucci’s price was too high, chief executive Serge Weinberg underscored that PPR has benefited from the fall in the dollar against the euro while steadily increasing its stake closer to the 70 percent threshold allowed by the put agreement by the end of the year.

“Our average cost stands at 84 euros [$90.72], which is well below the price of the put,” he wrote in last year’s annual report, recently distributed to investors in the United States. “At this price, and given Gucci Group’s exceptional growth potential, it is an excellent investment.”

Additionally, PPR got a windfall in May when Gucci said it would pay back $1.58 billion to shareholders this fall. The move effectively cuts the price of the put to $85.22 a share from $101.50.

The transactions have augured well for PPR, helping to elevate its stock from a low of about $48.60, or 45 euros, on the Paris Bourse this spring to current levels of around $84, or 78 euros.

Since the beginning of the year, PPR has disbursed about $540 million, or 500 million euros, to build its stake in Gucci to current levels.

The outstanding 30 percent of Gucci, which will depend on currency exchange rates at the moment the purchase is made, is expected to cost PPR about $1.99 billion, or 1.85 billion euros, or 21.6 percent of the group’s current market capitalization, according to a recent Morgan Stanley report.

“The aim is to transform Pinault-Printemps-Redoute into a retail and luxury goods distribution group, focusing on individual customers and responding to their requirements in terms of well-being and quality of life,” continued Weinberg in the annual report.

“Completion of this strategic shift will not only lend greater visibility and cohesion to Pinault-Printemps-Redoute, but will in fact improve the group’s profile: it will enjoy strong organic growth potential as well as a much improved return on investment.”

By the end of 2002, PPR had reduced its debt to $5.33 billion, or 4.94 billion euros, and improved its debt-to-equity ratio from 75 percent at the close of 2001 to 53.9 percent at yearend 2002, according to the annual report.

The improvement mostly reflected the impact of the disposals of its credit and financial services arm for $1.59 billion, or 1.48 billion euros, and the $383.4 million, or 355 million euro, sale of the mail order part of its Guilbert office supply business.

Early this spring, the second part of Guilbert’s business was sold for $880.2 million, or 815 million euros, and in April the Pinault Bois & Materiaux wood and construction business was unloaded for $610.2 million, or 565 million euros.

Meanwhile, two bond issues generated another $1.99 billion, or 1.85 billion euros, in cash.

Nonetheless, analysts estimate PPR’s net yearend debt for 2003 will stand at roughly $5.39 billion, or 5 billion euros, slightly higher than at the end of 2002.

Weinberg hopes to have completed the group’s massive strategic overhaul by the end of 2004. Rexel, the world’s leading distributor of electrical parts and supplies, is the only company in the business-to-business branch that remains to be sold.

Rexel’s sales in 2002 fell 4 percent to $7.95 billion, or 7.37 billion euros. Weinberg has said that CFAO, the African trading company, with sales last year of $1.75 billion, or 1.61 billion euros, will remain part of the group.

But even as luxury has inevitably sexed up PPR’s profile, it remained a mere 9.3 percent of total sales in 2002. The largely defunct business-to-business branch accounted for 43.7 percent of sales and financial services accounted for 2.9 percent.

Retail, now PPR’s main axis, brought in 44.1 percent of last year’s total sales. Besides its 29 Printemps department stores, the division includes the Fnac music and book retailer, the Conforama furniture chain and the Redcats catalog business.

PPR’s chief challenge is broadening those concepts beyond France, which last year generated upwards of 65 percent of the division’s total sales.

Even as the United States and Japan have showed signs of economic revival, the French economy suffered a sharper-than-expected fall in growth during the second quarter, falling 0.3 percent in the period.

The decline dampens hopes of recovery in Europe’s second largest economy and, if it persists, could make the second half an uphill challenge for PPR.