Strong Order Book Underpins Nick Scali

Small Caps | Aug 10 2020

Nick Scali expects net profit to improve substantially in the first half of FY21, having procured a robust order book that is supported by growth in the online business.

-Sector consolidation a possible growth avenue for Nick Scali
-Worked hard to ensure competitive lead times in May-July
-Online channel provides opportunity to diversify categories

 

By Eva Brocklehurst

Brokers have given a tick of approval to furniture retailer Nick Scali ((NCK)), which responded assertively to the curtailed trading environment over the final quarter of FY20 and produced a strong order book heading into FY21. The company expects an improvement in net profit of 50-60% in the first half, to $44.7m. However this is subject to no further extension of retail closures as a result of the pandemic.

Citi estimates customer deposits, a key indicator of forward sales, were up 43% at the end of FY20 on a per store basis. First half sales are expected to increase by 15% because of strong order growth between May and July.

The broker reiterates a Buy rating with a $9.80 target and expects growth in the medium term will be supported by the roll-out of online, which may partially offset the closures in Melbourne. Importantly, the pandemic disruption may provide opportunities for acquisitions.

Visibility beyond support from government stimulus is difficult so Macquarie finds it hard to assess how long consumer trends towards "at-home" of categories will be elevated.

Mindful of capitalising peak earnings and wage support, Macquarie, with an Outperform rating and $9.20 target, still assesses guidance is relatively conservative because of the implied assumptions beyond the current order book.

Sector consolidation remains a possibility as well as incremental opportunities from online and new store leases. The company reported strong sales growth and gains in market share in its FY20 results, benefiting from better lead times over competitors.

Brokers point out some competitors have struggled to maintain supply chains efficiently, with the lead times blowing out to around 20 weeks for one competitor. In contrast, Nick Scali worked with suppliers to ensure delivery lead times were within the usual 9-11 weeks by early May after delays were experienced in March and April.

Wilsons considers like-for-like sales growth at current levels is unsustainable and expects a moderation in the second half of FY21, as the impact of reallocation of capital and peak home investment wanes.

The broker anticipates the peak period of furniture and homewares purchases has already occurred during May 2020. As these purchases are typically large items and non-recurring, a reversion to more normal sales patterns is expected by the second half of FY21.

Wilsons downgrades to Market Weight from Overweight with an $8.10 target, on valuation, noting the stock is now trading at a 22.8% premium to related peers in the homewares segment on an FY22 PE (price/earnings) basis.

That said, the company's online/digital offering, which was expanded in April as a result of store closures, is likely to make a material contribution to sales. Margins in this channel are currently attractive, averaging around 30% and above store-level margins of 23%.

Wilsons assumes this segment will achieve 10% sales growth over the medium term, although notes this is well below the sales trajectory of Adairs ((ADH)) online which has averaged 51.2% over the past three years.

Nick Scali's online store business is weighted towards case goods (cabinets, desks, tables and chairs) as customers remain happy to buy some categories without physically viewing the product. This is less so with custom-built lounges.

Still, as Citi notes the online channel provides the company with an opportunity to diversify into new categories and it has significantly higher earnings margins while Macquarie highlights growth in the bedding category that was launched in 2019 across large format stores.

With travel and leisure restrictions, consumers continue to have limited avenues for expenditure and home builder and state assistance programs could also increase the level of renovations. Ergo, new furniture purchases.

Many of the company's customers are in the middle-upper income brackets and these homeowners are less likely to be adversely affected by the scaling back of JobKeeper, compared with younger consumers who are more likely to be employed in leisure, retail and travel.

Citi also asserts the market is ascribing little value to the company's land and buildings on the balance sheet, valued at around $75m, and the company is likely to continue purchasing property should there be no suitable business acquisition opportunities in the medium term.

Nick Scali has reduced its expenditure on print and radio advertising over the fourth quarter and will continue to focus on TV over the short term as consumers spend more time at home.

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