More Flair For Adairs In FY18

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Adairs finished FY17 with a flourish after a weak performance earlier in the year, as sales and margins were soft while inventory was cleared. Brokers envisage a better performance in FY18.

-Company's model considered relevant and defensive in an evolving retail environment
-Important to get fashion trends right in home furnishings amid heightened competition
-Long-term margins likely to be lower than current levels
 

By Eva Brocklehurst

Adairs ((ADH)) finished FY17 with a flourish after a weak performance earlier in the year, as sales and margins were soft while inventory was cleared. The company reports, in the first eight weeks of FY18, like-for-like sales have grown 13%. Guidance for FY18 operating earnings (EBIT) is $33-$37m.

The sales base gets even easier to cycle from this point on, so it would appear the company has some clear air, and Morgans suggests, given the first half decline in earnings, management is taking a conservative stance towards future guidance.

Adairs appears keen to trade out the first half of FY18 entirely, in order to rule out any other potential impact on performance besides its own product execution in the prior comparable period. Hence, a trading update at the AGM in early November could narrow or upgrade guidance, after there is four months of trading to take into account.

To illustrate, the broker struggles to get its operating earnings forecasts under the top end of the guidance range, and acknowledges like-for-like sales growth will be the key determinant. Morgans upgrades to Add from Hold and raises the target to $1.67 from $1.35.

Goldman Sachs, not one of the eight stockbrokers monitored daily on the FNArena database, maintains a Buy rating and increases its target by 9% to $1.61. Trading conditions are not expected to remain elevated for the rest of the year but the broker believes the company is well-positioned as a result of the initiatives taken in FY17. Weak comparables will also provide a tailwind.

Longer term, Goldman Sachs envisages the vertically integrated model, predominantly private-label offering, as being relevant and defensive in a quickly evolving retail environment. Less depth in inventory is expected in FY18 to reflect rolling out of stores and greater investment in winter product during July/August 2017.

The company has stated it does not want to carry extensive stock, in order to avoid running too much promotional activity. Goldman Sachs increases FY18 and FY19 forecasts for earnings per share by 6% and 4% respectively.

Online Sales

Cash conversion was strong, which pleased UBS, while debt was lower and there has been rapid online sales since the platform was re-launched. Earnings forecasts are increased by 6-8% and the broker and retains a Buy rating with a $1.65 target.

The company has re-set its online site, providing improved speed from browsing to transaction and an enhanced range, while offering Afterpay and Zip Money options. Online penetration in the second half lifted to 10.8% and the target has been brought forward to 12% in FY19.

Most sales online did not incur a delivery fee, such as Linen Lovers members and orders over $150, and UBS considers the business well-placed to handle the impending arrival of Amazon. The broker does point out that, given the per-unit distribution costs involved, rising online penetration would not be accretive to margins.

UBS believes the swings in top-line sales over the past 12-18 months show the importance of getting the fashion trend right in home furnishings amid increased competition in the industry. While volatility may weigh on the trading multiple the broker still believes the stock is attractively priced. UBS now forecasts 30% growth in operating earnings in the first half, based on 5.1% growth in like-for-like sales and an improvement in gross margins.

The company's pricing range appears to have tapped a mid-price fashionable home furnishings market that sits below the international entrants, although competitive pressure is increasing from both international and the discount department store channel. Hence, UBS expects long-term margins will be lower than current levels and estimates 9.8%, versus a 15.9% peak in FY16.

UBS forecasts the company to reach 212 stores by FY25, up from 160 in FY17. The broker's forecasts include 18 stores in New Zealand but a suspended Adairs Kids and Urban Home Republic network. Should the company open more Homemaker and Kid stores and expand to South Africa then UBS envisages potential for over 250 stores in the long-term.
 

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