Small Caps | Oct 06 2021
This story features NICK SCALI LIMITED. For more info SHARE ANALYSIS: NCK
Nick Scali will acquire Plush, another made-to-order sofa retailer, providing the scope to target a broader consumer demographic
-Plush is regarded a highly complementary business, expected to deliver significant synergies to Nick Scali
-Margin differences expected to narrow as synergies are obtained
-Nick Scali plans to keep both brands separate
By Eva Brocklehurst
Nick Scali ((NCK)) has settled on Plush-Think Sofas to expand its business to the couch potatoes of Australasia. The business has been acquired for $110m and will be funded through cash and new debt.
What is Plush? Plush is a specialist sofa retailer with 46 showrooms, positioned in the mid-range made-to-order market. Categories include modular lounges, chairs, recliners, ottomans and sofa beds. The model is similar to Nick Scali's in terms of the supply chain and category mix.
Macquarie observes this is a highly complementary business to the more upmarket brand of Nick Scali and a dual brand strategy should be able to target a broader customer demographic.
Nick Scali expects the transaction will be accretive to earnings in the first full year of ownership and before synergies, which were not disclosed. A two-year integration period is anticipated before material synergies should flow and Citi assumes -$5m in integration costs, likely to reflect redundancies.
Jarden agrees there is a strong strategic rationale given a complementary brand, scope to grow and both purchasing and cost synergies, estimating the deal will be 5% accretive in FY22 and 18% accretive in FY23.
The broker continues to expect the sales boost resulting from the pandemic will wane and rotation to travel/services from discretionary goods occur. This previously led to an Underweight rating for Nick Scali. Yet the macro environment remains favourable and this acquisition compelling so Jarden upgrades to Neutral with a target of $12.40.
Citi reiterates a Buy rating, raising the target to $16.80, and asserts, prior to the acquisition, consensus had been factoring in a -25% decline in earnings per share for Nick Scali, despite a strong housing cycle and FY22 order book.
The broker expects Nick Scali will move to a net debt position by the end of FY22 as it uses cash and raises new debt to fund the acquisition, and assumes $50m in new debt is raised and the remainder funded with cash.
In FY21 Plush generated $160m in revenue and $27m in underlying operating earnings (EBITDA). Macquarie notes an underlying EBITDA margin of 17% in FY21 compared with Nick Scali at 34%.
Jarden estimates gross margins for Plush of around 53%, higher than the industry average of 50%, because of its import mix. Through procurement benefits this should then grow around 200 basis points to 55% over the two-year integration period.
The broker also estimates the cost of doing business (CODB) margin is structurally lower than that of the core business of Nick Scali, primarily because of the volume/pricing difference. Acknowledging some assumptions, Jarden suspects Nick Scali's gross margin will decline by around -270 basis points because of the inclusion of Plush, and then improve from FY23-25 as synergies are obtained.
Citi acknowledges Plush has lower sales per store and margins compared with Nick Scali but highlights the opportunity to significantly increase overall scale that will in turn generate supply and cost synergies.
Moreover, Nick Scali is considered better placed to negotiate rents, given the leverage from the owned part of its property portfolio, and while the overlap in terms of suppliers is limited, the company can leverage established relationships with China and Vietnam to reduce sourcing costs for Plush.
Citi's analysis shows around 68% of Nick Scali stores have a Plush store located within 5km, likely a function of large format retail sites where home contents retailers are typically located. Despite the overlap, Nick Scali plans to keep both brands separate.
There will now be 108 showrooms across Australasia with opportunities for new stores as well. Nick Scali expects to be able to open new Plush stores in areas which are under represented.
Plush has a long-term target of 90-100 stores in addition to Nick Scali's target of at least 85 stores from the current 62. Citi notes Plush stores are typically half the size of Nick Scali stores and hence there appears to be significantly more roll-out opportunity for the former.
Currently Plush has no stores in New Zealand which could be an expansion opportunity, the broker adds, given Nick Scali has successfully expanded its presence there.
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