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Geoff Lowery of Dresdner Kleinwort was remarkably prescient with his downgrade of DSG International. Within 24 hours the group issued yet another profits warning which underlines its fundamental problems. The group confirmed that 2007/08 profits would be some £200 million to £210 million, some 7% below consensus estimates and well below the £295 million earned last year.

The group is suffering from ‘challenging’ conditions in each of its three main markets, the UK, Spain and Italy. The only part of the business which is performing strongly is e-commerce which in fact exposes the group’s basic problem. As the net becomes more popular sales are migrating from the group’s stores, which has led to a substantial decline in margins, which have fallen by 100 basis points since Christmas.

The situation in Italy has worsened since the January trading update. Lowery believes underlying sales are down by 15% to 20% since Christmas despite very competitive prices.

In the UK the group has suffered a severe downturn in PC sales which have fallen by 9%. Sales of white goods and TVs have been driven by promotion rather than strong underlying demand. Following the trading update Lowery cut his forecasts dramatically. He is now forecasting profits of £206 million, implying EPS of 7.7p.

More importantly, Lowery believes that the group is facing severe difficulties as it enters 2008/9. With consumer confidence declining and competition becoming even more severe he believes that profits will fall still further. He is forecasting profits of £155 million, half of the level the group reported in 2005/6. However, he believes that there is still ‘downside risk’.

Historically the 8.8p dividend was regarded as a prop to the share price. However, following the latest profits warning Lowery is now forecasting that the dividend will be halved to 4.4p, which will be covered only 1.4 times next year.

John Browett, the new CEO, is due to unveil the first phase of his strategic review on 15 May. Lowery believes that he will need to produce ‘fundamental action on Italy, gross margin and stores’ in view of the ‘significant structural and cyclical head winds’ battering the company. Already DSG has indicated that it will review the carrying value of the goodwill associated with Italy. However, much more stringent measures will be necessary. Two years ago it altered the fascias on its UK stores from Dixons to Currys. It will now have to announce substantial closures. Lowery has now reduced his target price to 48p, implying a PE for 2008/9 of just eight.