Small Caps | Dec 05 2019
Adairs has expanded its range of home furnishings with the acquisition of NZ-based furniture and homewares business, Mocka.
-Mocka expected to help shape the longer-term growth outlook for Adairs
-Forecast to produce 17-23% growth in earnings per annum
-Competitive pressure in home furnishings increasing with international arrivals
By Eva Brocklehurst
The addition of NZ-based furniture and homewares business, Mocka, will provide Adairs ((ADH)) with increased exposure to the online sales channel, lifting this to 30% of total sales. The acquisition has added to the Adairs furnishings range, as 65% of Mocka sales are of furniture.
Mocka, a pure online retailer, has experienced strong top-line growth and generated earnings (EBIT) margins of 21-22%. Mocka sells home furniture, decor and childrens' categories. Sales of NZ$45m are expected in FY20. Wilsons suggests the acquisition will help shape the longer-term growth story for Adairs, envisaging potential upside from omni-channel options, online distribution leverage and key supplier terms.
Adairs is forecasting 17-23% growth in earnings per annum for Mocka, supported by category growth and improved brand exposure in Australia. Guidance does not take into account any cost synergies and, while both teams will remain separate, Wilsons suspects Adairs may start to look at supplier distribution terms almost immediately.
Morgans agrees the deal elevates the Adairs growth profile in a low-risk way and articulation of long-term returns from the supply chain presents a further catalyst the first half result in February.
The total consideration is $85-91m comprising $43.4m in cash and $5.7m in scrip up front. The balance in deferred payments will be based on earnings hurdles. Mocka has achieved a compound revenue growth of 32.6% since FY17. Current forecasts imply growth in New Zealand may be slowing but growth rates in Australia remain robust and have far greater potential.
Moreover, considerable expansion of market share is still achievable in Australia, Wilsons points out, as Adairs, in turn, offers Mocka opportunities. Adairs will allow the existing Mocka management to run the business separately while Mocka should benefit from the Adairs Australian customer base and scale (55% of Mocka revenue is in Australia) to enhance brand awareness.
While the price of the acquisition is not cheap, Morgans notes it is rare to acquire an online business that is profitable and light on capital requirements. The broker includes the acquisition in modelling, which results in 9% accretion in FY20 and 15% in FY21, and retains an Add rating and $2.42 target for Adairs.
Wilsons calculates a 100 basis points improvement in the Mocka gross margins would result in 4.8% upgrades to earnings in FY20 and has an Overweight rating and $2.76 target. UBS, too, considers Adairs is a well run, cash generating business with a solid growth profile, maintaining a Buy rating with a $2.60 target.
While fashionable home furnishings are unlikely to be a fad, competitive pressure is increasing, the broker adds, although the company appears to have tapped into a market that sits below the international entrants, being mid-priced.
UBS expects Adairs to reach 190 stores by FY28, up from 165 in FY19, and suspects 'upsizing' will be the name of the game in future, as opposed to increasing the store count, and this will be done via the roll-out of homemaker stores and increasing the space of the small format stores.
The Adairs debt facilities have been increased to $90m to fund the majority of the deal. Adairs has also reiterated its underlying guidance for FY20 (ex Mocka) at $43-46m, emphasising it is well-placed in terms of planning and inventory ahead of the important Christmas trading.
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