Nick Scali (ASX:NCK) shares have materially re-rated since our POSITIVE recommendation in October last year in our weekly research report The Dynamic Investor. After the Company reported its interim results (1H21), we revisited the fundamentals in order to assess the prospect for a further re-rating.
About Nick Scali
Nick Scali is a furniture retailer operating in Australia and New Zealand (NZ). The business operates under a single brand, Nick Scali Furniture. The Company now has a total store network of 60 stores across Australia (56) and NZ (4) and has a long-term overall target of at least 85 stores.
Key Fundamental Drivers
1. There is a High Degree of Certainty in Sales Growth
Sales momentum from 1H21 is expected to continue over the short term at least, given that there is typically a positive relationship between written sales order growth and Like-for-Like (LFL) sales growth in the next half. On this basis, given the strong written sales order growth over 1H21 (up 52%) and January 2021 (up 47%), Like-for-Like sales growth of +30% is expected in 2H21. The Company is also managing its supply chain very well while some competitors (especially smaller ones) have struggled to managed their supply chains.
Macroeconomic conditions are also supportive of sales. In particular: i) The average savings rate over the period June – September 2020 (20%) was significantly higher than the long-term average of 9%, ii) Increasing housing churn over six months to December 2020 is a positive for furniture sales and iii) A surge in HomeBuilder applications during December 2020is expected to support Nick Scali’s medium sales momentum as furniture is typically purchased later in the construction/renovation cycle.
2. Increasing Scale of NZ Operations Expected to Boost Operating Leverage
The 1H21 result indicated a strong performance by the NZ business, with sales growing by 21% supported by strong sales order growth (LFL sales order growth of 42%) which has continued in January 2021. The Company expects a greater contribution from NZ in 2H21 as the business grows in scale. In particular, NZ has plenty of capacity to ramp up from the existing network of four stores. NCK has not yet fully leveraged the fixed cost infrastructure in NZ
3. Multiple Benefits from Online Momentum
NCK’s online offering has performed very well since its launch early in 2020. The greater focus on the online offering provides the Company with growth opportunities in new categories as it does not have space constraints of a traditional store. To this end, management are planning to launch new online only categories/SKUs, lounge configuration and transactional functionality. We also consider that NCK’s current sales mix towards custom lounges mitigates the threat from online furniture retailers.
4. Net Cash Balance Sheet Offers Opportunity for Business & Store Acquisitions
NCK has a strong net cash position, which is supported by $80.6m of land and buildings at cost as at 31 December 2020. At the 1H21 results release, the Company indicated current Merger & Acquisition (M&A) opportunities are significantly higher than historical levels. NCK is likely to consider brands that can leverage supply-chain/merchandising synergies across a wider customer demographic.
Aside from potential M&A opportunities, the Company can fund the planned expansion of its store network. As at 31 December 2020, the Company had a total network of 60 stores across Australia and NZ. NCK has increased the long-term store target, from 80-85 stores, to “at least 85”. The majority of the new store pipeline is likely to come from NZ.
Consensus estimates continue to factor in a significant decline in EPS growth in FY22, on the back of tapering government stimulus and a pull-back is sales orders upon: i) A reversal of the COVID-19-driven trends which have supported recent results (i.e. increased expenditure on the home) and ii) Expectations that the currently-supportive macro conditions will not be sustained.
Notwithstanding the weakness in the share price post 1H21 result, the shares continue to be highly rated by the market, given management’s track record of execution. In particular, NCK has shown an ability to maintain attractive gross profit margin irrespective of business cycle and currency trends.
In our most recent report on the Company we noted that any further upside from those levels would have to be driven by utilisation of the balance sheet for business/store acquisitions in order to provide a further growth leg.
NCK has recently struggled to push through $12 and it appears as though we will see lower levels in the short term. Ideally we would be looking for some support to come in near $10. If that were to occur, then that would be a potential buying opportunity. However, the pace of the recent decline is a bit larger than normal so there is probably a higher chance that NCK suffers a deeper pullback towards $8 – $9 instead. Once there we will have to assess whether there is enough support to start buying again.
Michael Gable is managing director of Fairmont Equities.
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