The high quality retailer trading at a bargain

This time last year, NSW and Victoria were in lockdown. Many retailers were forced to close their doors for months. Australia’s largest furniture retailer had 55% of its stores closed for three months. It wasn’t a good sign for FY22 financials. The woes only continued in the second half of the year with supply chain issues, rising inflation and increased freight costs.

And yet, today Nick Scali (ASX: NCK) announced a revenue increase of 18% to $A441m, an outstanding result given the circumstances.

The results have been no surprise to Tim Carleton, Principal and Portfolio Manager at Auscap Asset Management. He names Nick Scali as one of the highest conviction stocks in his portfolio.

“It is a very strong result, but just as importantly, a strong outlook where a lot of operational levers are within their control to pull to offset any potential revenue weakness.”

In this wire, Tim shares some of the highlights from Nick Scali’s FY22 result, and gives us his outlook on the company and its sector for the year ahead.

Nick Scali Limited (ASX: NCK) FY22 key results

Note: This interview took place on Monday 22 August. This stock is a core holding in the Auscap Long Short Australian Equities Fund portfolio.

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What were the key takeaways from this result? What surprised you the most?

I don’t think anything surprised us because we’ve been a shareholder in Nick Scali for a long time. It was a strong result, and it demonstrates that they are one of the best retailing outfits in the market. The core business remains very resilient to date. Despite all the market concerns about the housing slowdown, the acquisition of Plush is tracking ahead of our expectations. Management is extracting very significant operational synergies. To put that in context, management have forecast a reduction in operating expenditure by $13 million to $40 million in FY23. 

They’re also introducing new ranges into Plush with two aims:

So the core business is doing very, very well. The Plush acquisition is exceeding market expectations quite substantially. Then there’s an online business in the early stages of maturity. It only become a fully fledged eCommerce business in the last quarter of FY22 and it’s already very profitable and giving them another avenue for growth. 

The result was a very strong one and that was in the context of significant concerns of how the broader macro environment is affecting furniture retailers.

What was the market’s reaction to this result? Was this an overreaction, an under reaction or appropriate?

As we look into FY23, there are a lot of things in their favour:

• They have a significant order bank that will be realised over the course of the first half.
• Their trading in July was quite strong compared to the previous year.
• There’s operational improvements within Plush that will start flowing through their earnings.

These are the factors that effectively give you a buffer in the event of slowdown. We wouldn’t be surprised to see the company re-rate as portfolio managers and analysts work through the details. It is a very strong result, but just as importantly, a strong outlook where a lot of operational levers are within their control to pull to offset any potential revenue weakness.

Would you buy, hold or sell Nick Scali on the back of these results?

Rating: BUY

It’s probably no surprise to say that from our perspective, it’s a buy. I’d go as far as saying it’s one of our highest conviction positions.

For a company of this quality to be trading on the multiple they’re currently trading on is an exceptional opportunity for investors.

What’s your outlook on Nick Scali and its sector over FY23?

We don’t have a crystal ball on furniture spend but we do have an understanding of how the market is thinking. It’s fair to say that the bearish outlook is more than baked in. The market is looking at rising interest rates. It’s extrapolated what that means for property prices, housing turnover, new housing construction and has priced in a reasonably bearish scenario that flows into furniture sales. It’s always helpful when revenue expectations are relatively low because there is potentially more upside than downside. On the other side, freight costs are declining which should be a tailwind over the course of FY23.

There are a lot of operational improvements and developments that give us comfort that there are plenty of levers they can pull to offset any potential slowdown in furniture sales. From our perspective, the outlook for Nick Scali is very positive.

Are there any risks to this company and its sector that investors should be aware of given the current market environment?

Nick Scali are part of a broader economy. We’re in a rising interest rate environment and that has the potential to curb expenditure on big ticket items as well as slowing housing activity and construction. The question on that front is whether risks have been priced appropriately. Individual investors will need to make their own evaluation of that.

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious on the market in general?

We focus on buying best of breed businesses when people are very cognisant of macro risks. That’s often when you get to buy high quality companies at a meaningful discount to what we think they’re worth. We would certainly put Nick Scali in that camp at the moment.

As to the market in general, we look at individual opportunities and when they’re compelling, we add to our investments. If we’re not seeing anything then we sit on our hands. We try hard not to take a broad view unless we’re in a circumstance where everything looks compellingly cheap or the converse, where everything is particularly expensive. I don’t think we sit in either of those camps at the moment. We’re probably slightly more positive on the economic outlook than the majority might be. It doesn’t affect our positioning in a huge way.

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