A three-piece update to Nick Scali furniture

Nick Scali (ASX: NCK) released a trading update along with first half earnings guidance. Most analysts conclude that the update was a downgrade to the first-half consensus net profit after tax (NPAT); longer-term investors will look beyond the short-term effects of higher freight charges.

The headline numbers are as follows: 

• The company's 1H25 group NPAT guidance is now $26.3-$29.7 million, versus consensus estimates of $36 million. 
• Australia and New Zealand NPAT is expected to be $30-33 million. 
• Meanwhile, Australia and New Zealand's 1H25 revenue guidance is $217-$222 million, compared with consensus estimates of $227 million. 
• Gross margins are also lower than consensus estimates of 65.1% (in line with FY24), at 63.6%
• Finally, the new UK business is forecast to produce a loss of $3.3-$3.7 million, which looks a little better than expected.

On first brush, the update looks like a 22% miss to NPAT expectations, and it is being driven by a worse-than-expected 240 basis point impact on gross margins from "materially higher unexpected freight rates".

There is also the UK business, Fabb Furniture, which Nick Scali purchased in May. The strategy is to transform the business to the Nick Scali business model and leverage the group's capabilities for efficiency and scale before then moving on to expanding the store footprint.

Customer orders for Fabb Furniture items, at Fabb Furniture prices and margins, are flowing through with a benefit arising this half from an acceleration of order fulfilment after prior supply chain disruptions. Keep in mind revenues are booked when items are delivered, not when they are ordered. This 'order bank unwind' benefit will normalise in future periods. Indeed, the company noted it expects the second quarter of UK-delivered sales to be reduced, to be closer to the volume of written sales orders in the first quarter.

Domestically, the company noted back in August, at the release of the full-year results, that written sales order growth for June and July combined was down 1.2%. The reason for combining the months was July this year lacked an additional weekend the prior corresponding period enjoyed (keep in mind almost 80% of business is conducted on weekends).

Now, written sales orders for the four months to September 2024 have increased by three per cent compared to 2023, with both August and September higher than the prior year. The company still expects to open two Nick Scali stores and five Plush stores in FY25, with most openings in the second half.

So, revenue in Australia and New Zealand looks fine despite a longer-than-expected period of higher interest rates having a negative impact on renovations, new builds and housing sales activity.

With the higher-than-expected shipping costs, it seems freight companies might not be honouring their contracts and are hitting customers with higher costs upon arrival before releasing goods. The good news is that although rates are double where they were last year, shipping rates are starting to decline, as Figure 1 reveals.

Finally, we believe the good news will start to appear as the company completes its sell-down of Fabb Furniture stock, commences putting through the Nick Scali range of furniture, redesigns and rebrands the UK stores and then begins the expansion process. This process takes years, not months, and given investors tend to overestimate the short term and underestimate the long term, we believe the share price weakness on the back of the trading update will be short-lived. 

Indeed, the earning multiple is not that of a company with solid offshore growth. A re-rating accompanying earnings growth is not beyond the realms of possibility.