The high quality retailer trading at a bargain

Sara Allen

Livewire Markets

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 coming year looks promising too. Nick Scali’s outstanding order bank of $185.3m (up 67.1%), growing online business and the acquisition of Plush-Think Sofas is expected to translate to increases in sales revenue this financial year.

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.

Tim Carleton, Auscap
Tim Carleton, Auscap

Nick Scali Limited (ASX: NCK) FY22 key results

  • Revenues up 18.2% to $A441m
  • NPAT down 11.1% to $A74.9m
  • EBIT down 2.8% to $A124.6m
  • Gross margin down 1.5% to 61%
  • Costs of doing business up 3.9% to 35.2%
  • Outstanding order bank up 67.1% to $185.3m
  • Total written sales orders of $473.8m, up 18%.
  • Earnings per share down 11.1% to 92.5c
  • End of year dividend of 35c, up 6.7%

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

Managed Fund
Auscap Long Short Australian Equities Fund
Australian Shares

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

The Nick Scali team are always conservative in their approach to forecasting the market but they’re very focused on what they can deliver on. They had a clear plan they executed on when they took control of Plush. I suspect they found more opportunities to extract synergies than they expected prior to purchase. They are a world-class furniture retailer, led strongly by Anthony Scali.

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:

  1. To introduce them at a more attractive price point for the quality than previous offerings.
  2. Achieving better gross margins for the business.

It’s a twin positive of better customer value and higher profitability for Nick Scali. The proof has been in the pudding pretty early on. They introduced three new lounges in July. One of them has already become the best seller within Plush at an above average gross margin. They intend of replacing nearly half the product set within the Plush business. This should result in very significant improvements in the profitability of that business under Nick Scali ownership.

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?

Initially it was a surprise to the market but that corrected itself once portfolio managers and analysts had time to go through the numbers. In the end, the stock finished 5% up which didn’t surprise us. Ultimately you have a company trading on a P/E of 10 and that’s their actual earnings. 

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’s a growing store network. Keep in mind that this is a company that has outlined a near doubling of the store network in its longterm targets. There’s an immature online business which is already very profitable and should continue to develop to provide earnings growth. Nick Scali only owned Plush for 8 months of the last financial year so this year will see a full year of sales. This is in addition to significantly improving margins within that business.
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.
Compared to its peers, Nick Scali controls its supply chain very well and are very efficient in how they manage their business. That’s in terms of working with their suppliers to deliver high quality products at attractive margins and good value while maintaining a lean corporate structure. I think one of the biggest things that surprises customers when they walk into a Nick Scali store is the value and offer. The reason they can deliver great value to customers is they have an efficient operational set up.

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

There’s two parts to this.

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.

In addition, there are always company-specific risks around execution. From our perspective, you have a team that has done this for many years and proven adept at reacting appropriately to market circumstances while delivering results for shareholders.

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.

Catch all of our August 2022 Reporting Season coverage

The Livewire Team is working with our contributors to provide coverage of a selection of stocks this reporting season. You can access all of our reporting season content by clicking here
........
Auscap Asset Management Limited’s (“Auscap”) views discussed above are based on factual information available to Auscap as at 22 August 2022. Auscap’s views and market conditions as expressed above may change without notice. The above information is not general advice, personal advice or a recommendation to be relied upon when making an investment or other decision. While all reasonable care has been taken to ensure that the information above is complete and correct, no representation or warranty is given as to the accuracy of any of the information provided. Livewire gives readers access to information and educational content provided by financial services professionals and companies (“Livewire Contributors”). Livewire does not operate under an Australian financial services licence and relies on the exemption available under section 911A(2)(eb) of the Corporations Act 2001 (Cth) in respect of any advice given. Any advice on this site is general in nature and does not take into consideration your objectives, financial situation or needs. Before making a decision please consider these and any relevant Product Disclosure Statement. Livewire has commercial relationships with some Livewire Contributors.

1 stock mentioned

1 fund mentioned

1 contributor mentioned

Sara Allen
Senior Editor
Livewire Markets

Sara is a Content Editor at Livewire Markets. She is a passionate writer and reader with more than a decade of experience specific to finance and investments. Sara's background has included working at ETF Securities, BT Financial Group and...

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.

Comments

Sign In or Join Free to comment
Elf Footer