Small Caps | Feb 09 2021
This story features NICK SCALI LIMITED. For more info SHARE ANALYSIS: NCK
How long will sales momentum stick around for furniture retailer Nick Scali, or are orders at a peak?
-Freight costs offset by reduced discounting, FX hedges roll
-Online sales expanding but weighted to case goods
-Acquisitions the likely catalyst for further outperformance
By Eva Brocklehurst
Are furniture sales orders at a peak for Nick Scali ((NCK)) or will the momentum in the housing market allow strong growth to continue over 2021?
Wilsons believes the current rate of sales growth is unsustainable and there are signs a slowdown is emerging, while sales orders could be close to a peak. On the other hand, Citi suspects trading may stay above pre-pandemic levels over the next twelve months because of international travel restrictions.
Current shipping delays mean the second half will include back-dated orders and the company has acknowledged challenges with its supply chain. The duration of supply-chain bottlenecks is hard to predict, yet Macquarie points out freight costs have been offset by reduced discounting and FX tailwinds as hedges roll off.
Citi brushes the issue aside, believing the challenges are largely a timing issue for revenue recognition and if smaller competitors find it hard to secure stock this will lead to market share gains for Nick Scali. Macquarie believes competition for market share will accelerate as demand normalises and some of the savings will return to expenditure.
Brokers agree the December 2020 surge in HomeBuilder applications should support sales momentum as furniture is a late-cycle purchase. Discretionary expenditure over 2021 should also be sustained from a higher savings rate over 2020 among consumers, as well as the improvement in housing churn.
First half net profit was in line with guidance, at $40.5m, and Wilsons does upgrade FY21 and FY22 net profit estimates to reflect improved cost management and subsequent margin expansion.
Nevertheless, the broker is conscious that growth could stagnate once stores are operating normally and believes the valuation is full, retaining a Market Weight rating, and reducing the target to $9.60 on the back of the report.
Macquarie suspects the market reaction is consistent with other updates from retailers that signal investors are unwilling to capitalise recent upgrades beyond an assumed level of sustained earnings. Written orders were elevated in January, the broker notes, and despite this being the strongest month of the year it was constrained by the ability to service customer foot traffic into stores.
As a result, the order book will push much of the elevated consumer demand that has been seen to date into future results. Macquarie found the order book the main highlight of the first half and retains an Outperform rating with an $11.10 target.
Citi believes Nick Scali can benefit further in 2021 from a consumer focus on the home and as comparables are factored into consensus expectations there will be upside stemming from improved housing churn. A strong balance sheet also means Nick Scali can respond with accretive acquisitions.
Citi conservatively forecasts a decline in earnings per share of -39% in FY22 and has a Buy rating with a $12.05 target. The new target, raised from $11.65, is underpinned by a higher long-term roll-out strategy as the company increases its target to "at least 85 stores" from 80-85 stores.
The opportunity for store roll-out exists in New Zealand followed by Victoria, Citi's analysis points out, and the company has identified a prospective 14 stores in New Zealand. This is a similar number to the stories held by competitor Freedom Furniture in New Zealand.
Nick Scali has expanded its online offering since April 2020 and will expand further. Lounges represent 30% of sales in the online channel and Wilsons expects this can provide upside to the platform. Online earnings of $3.5m exceeded company expectations.
The main positives are the opportunities from new categories as there is not the space constraints that exist with a traditional store. Citi notes online trading appears to have limited cannibalisation of store sales, unlike the opening of new stores.
Moreover, online channels have higher earnings margins for the group as there is limited employee costs and greater skew towards case goods (furniture designed for storage, such as cupboards, chests of drawers, wardrobes…). Citi also suspects a strong online offering would increase the company's negotiating power with landlords.
Macquarie notes the up-selling of inbound inquiries helped improve average transaction value online but the channel remains heavily weighted towards case goods, which are generally lower priced compared with custom lounges.
The company has explicitly outlined capital-led initiatives and included acquisitions in its forward planning, also intending to increase property ownership in key areas of growth. Citi expects Nick Scali will be able to derive synergies through better sourcing and rental deals.
Wilsons also considers the store roll-outs an attractive strategy which will help ensure important sites are retained over the long term. The broker points out, given current interest rates, Nick Scali could save $4.0m per year if 10 stores were converted to an owned model. Nick Scali currently leases the vast majority of its stores.
Macquarie assesses Nick Scali is "somewhat differentiated" because of the amount of sales being carried forward, although concedes the catalyst for further outperformance may need to come from consolidation/M&A.
[Note: Having doubled profits in the first half FY21 to $40.5m, Nick Scali has bowed to political pressure and agreed to return the $3.6m of JobKeeper it received.]
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