Small Caps | Oct 27 2020
This story features ADAIRS LIMITED. For more info SHARE ANALYSIS: ADH
Adairs has had a stellar sales performance in the first half to date, despite the lockdowns, proving the potential of its online offering amid continuing strength in home furnishings.
-Market share gains continue
-Online sales growth to retain a strong trajectory
-Yet concerns linger about FY22 comparables
By Eva Brocklehurst
Strong sales growth over the first half to date have increased confidence in Adairs ((ADH)), as the business benefits from currency tailwinds and a continuing trend to purchase home furnishings.
Importantly, sales growth was achieved in the wake of broader inventory shortages and despite 43 stores in metropolitan Melbourne being affected by lockdowns since August. This, in turn, has had a positive impact on gross margins. Gross margins are expected to normalise from November, as restrictions are lifted and consumers encounter alternative avenues to spend their money.
As Morgans points out this elevated demand will need to be cycled in six months time. Still, the broker was surprised by the strength in gross margins, up 600 basis points for Adairs and up 150 basis points for Mocka. Sales in the year to date were up 22% for Adairs and up 48% for Mocka.
The company has warned investors against projecting sales and margin growth across the balance of FY21 because of the uncertain economic environment. As a result no FY21 guidance has been provided.
The sub-optimal inventory position, while since resolved, benefited margins as did lower promotional activity. Adairs has indicated costs continue to be well contained despite its focus on acquiring customers.
Therefore, Morgans envisages no reason why strong operating leverage cannot continue, at least throughout the first half. Wilsons forecasts gross margin of 63.0% in FY21, declining to 57.9% in FY22 and remains cautious about volatility in the second half as well as a first half of FY22.
Sales are expected to move back to Adairs stores in the second half and gross margins normalise, while there should be some contraction in online margins because of increased freight costs. The broker explains this should subsequently improve as sales continue to grow online and result in operating earnings margin (EBITDA) expansion over time.
Gains in market share were evident and UBS believes there is scope for continuing share growth as a result of higher purchasing frequency from newly acquired customers as well as store "flexibility", as 42% of leases expire in around 12 months.
UBS believes the market is under-appreciating the online business, which it assesses is around 40% of earnings. The broker notes online contribution margins are around 1.4x higher compared with in-store margins. Online is expected to grow to more than 40% of sales by FY25 and risks are to the upside.
Given the attractive growth achieved online, Wilsons, in simply assuming sales were transferred from the retail to the online channel, calculates underlying growth is 60.4% in online. The broker has an Overweight rating and $4.13 target, to reflect an attractive outlook for the medium-longer term and not the current volatility.
The broker anticipates EBIT of $81.8m in FY21 and $81m in FY22. Assumptions for Mocka are upgraded, given an improved website and increased product cross-over with Adairs Kids, to reflect a sales growth profile similar to Adairs online.
Despite the "pretty exceptional" update and material upgrades to estimates, the share price has declined and Morgans believes this reflects concerns regarding whether the strength in sales will persist.
The broker is not unduly worried, believing current earnings levels are not being capitalised at onerous levels and the stock continues to trade at a large discount to peers. The business is comfortably net cash and, therefore, has flexibility to pursue other growth avenues.
Morgans now forecasts FY21 earnings (EBIT) of $84m and retains an Add rating and $4.35 target, while acknowledging the fourth quarter and first half of FY22 remain uncertain.
UBS upgrades estimates by 15-39% but anticipates a -8% drop in FY22 underlying earnings, agreeing uncertainty over the 12-month outlook is significant but assessing the valuation reflects this and sticks with a Buy rating and $4.00 target.
Moreover, UBS agrees the business can withstand significant like-for-like declines given surplus capacity on the balance sheet by the end of the year. Over the year to date the trends are materially ahead of assumptions for both sales growth and margins and, as a result, Goldman Sachs maintains a Buy rating and $3.65 target.
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