Adairs Spring Cleaning Pays Off

This story features ADAIRS LIMITED. For more info SHARE ANALYSIS: ADH

Homemaker retailer Adairs recovers from bed linen buyer mistakes and aims to steadily expand and improve retail execution

By Nicki Bourlioufas

-Adairs shares spike after positive earnings guidance; more gains seen
-Potential for growth in store expansion and better retail execution
-Risks lurk in intensifying competition and cooling housing market

Analysts say share price rise justified

Adairs ((ADH)) share price shot up 30% on Wednesday after the manchester and fashion homewares retailer said its 2016-17 result would be at the top end of its profit guidance. The improved outlook is based on a significant recovery in fourth-quarter sales.

The improvement partially offset Adairs’ downward trajectory since it listed in June 2015.

The stock fell by -40% in November 2016 after the company warned full-year performance would be affected by its failure to respond to a shift in bed linen fashions. The share price fell further in February after the company reported a -35% slump in half-year profit.

Adairs closed at $1.275 on Wednesday, well above its June 2017 low of $0.56, after the trading update by chief executive Mark Ronan.

Analysts at Goldman Sachs, UBS and Morgan responded positively to Ronan’s statement, indicating they see potential for the stock to rise even further.

Goldman Sachs was most optimistic, reiterating its Buy recommendation and raising its target price to $1.48. It sees Adairs’ vertically integrated model, in which private label products account for 90% of sales, as remaining relevant and defensive in a challenging retail environment.

UBS also maintained its Buy rating with a target price of $1.45, up from $1.16, saying Adairs is a vertically integrated retailer with a best-in-class supply chain operating in a fragmented industry.

Morgans, however, pulled back its rating from Add to Hold, while lifting its target price to $1.35 from $1.20. It said Adairs’ new product hitting shelves is clearly resonating with consumers, although promotional activity remains key to foot traffic and sales.

What’s driving the action?

Adairs has an online store and 130 stores in five formats: Adairs, Adairs Homemaker, Adairs Kids, Urban Home Republic, and outlets.

The retailer plans to open eight to 12 new stores a year over the next five years in Australia and New Zealand, and possibly South Africa.

The company expects FY17 sales to total $264.9m, at the very top of its prior guidance of $255m to $265m. Earnings before Interest and Tax (EBIT) are expected to come in between $30.5m and $31m, again close to the top end of its guidance of $27m to $32m.

Adairs’ statement focused on a 3.8% fourth quarter increase in like-for-like sales, a calculation that strips out store closures and openings. Importantly, like-for-like sales improved in bed linen, which accounts for 40% of sales.

UBS notes the company’s issues with this key category appear to be over, “with old stock largely cleared from stores. Adairs did benefit from Easter timing and cooler weather in the fourth quarter. However, the company saw strong sales in June, which is genuine like-for-like growth, in our view.”

Adairs also put on record that it had experienced higher-than-usual variations in sales performance across centre types, product categories, store formats and geographies.

Goldman Sachs finds the variability was largely driven by broader retail conditions, but also that it pointed to opportunities for Adairs to improve retail execution at both the product level and store level.

Morgans suggests another factor in the second-half recovery is likely to have been Adairs’ success in negotiating better rental terms. The company’s store leases average five years, so Adairs typically renews 20% to 25% of its leases each year.

“We expect an increased focus on extracting better rental terms going forward, which should provide further cost productivity tailwinds in coming years,” the broker said.

Holding steady in a fickle market

Adairs’ offerings appeal to the mid-priced market for fashionable home furnishings, with competition coming from higher-priced retailers above – particularly international entrants – and from discount department stores at the lower end.

UBS says Adairs “is benefiting from a strong housing cycle in Australia and an increasing focus on higher-margin fast-fashion bedding and homewares products.”

The company appears to have tapped into a mid-priced fashionable home furnishings market that generally sits below the international entrants, points out UBS.

But these entrants and discount department stores are increasing competitive pressure and this could be expected to increase over the medium-term.

UBS pinpoints the major near-term risks as being associated with the implementation of Adairs’ new point-of-sale system. It also warns of possible inflation in the cost of imported products if the Australian dollar falls.

In the near term, Adairs faces a weakening macro-economic environment and would be hard-hit by any slowdown in the housing cycle.

But Goldman Sachs counters its economic team is tipping an improvement in the broader consumer environment in 2017-18, and such a development would boost Adairs’ performance.

The concerns around competitive pressure from discount department stores may have been overdone, Goldman Sachs adds.

Morgans has identified risks in any possible depreciation of the Australian dollar, weak like-for-like sales growth, increased competition, weak product execution, and industry discounting, which would put pressure on margins.

Over the long term, Morgans says, the maturity of the homemaker category could put the brakes on growth, and new entrants – particularly internationals – could enter the market.

There is also the risk of failure in the emerging formats – Adairs Kids and Urban Home Republic – and in the expansion into offshore markets.

FNArena's market consensus forecasts shows Adairs fortunes should continue to improve in FY18, with dividend payout to lift to 7c per share, translating into a yield of 5.5% at yesterday's closing share price.

The consensus price target, derived from two brokers (Morgans and UBS), sits at $1.40, suggesting 9.4% upside ex-dividends.
 

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