Adairs: Will current earnings prove sustainable?

About the author:

Josephine (Jo) Little
Author name:
By Josephine (Jo) Little
Job title:
Senior Analyst
Date posted:
08 December 2020, 4:00 PM
Sectors Covered:
Consumer Discretionary (Retail)

  • Adairs' (ASX:ADH) strong sales trends have continued, with Adairs total sales +23% and Mocka +45% YTD.
  • The re-opening of Melbourne has seen in-store sales bounce back quickly (LFLs +5.2% and +17% excluding the Melbourne closure period), while online sales growth continues to show strong momentum (+100% yoy).
  • Material upside to ADH’s current valuation/rating will ultimately lie in its ability to demonstrate that current elevated earnings levels are sustainable – which is 6-12 months away from prove-up, in our view.
  • In the meantime, we expect ADH’s balance sheet to be in a strong net cash position. This provides ample flexibility for ADH to potentially pursue additional opportunities (akin to Mocka). Add maintained and updated price target (login to view price target).

Online and in-store supporting strong growth

ADH provided a trading update (first 23 weeks of 1H21), comprising: Adairs LFL sales growth +5.2% (+17.3% excluding Melbourne closures during this period); Adairs online +100%; and Mocka +45% yoy.

This highlights a healthy combination of in-store and online growth in the wake of restriction/social distancing easing. We understand the online growth is coming from both new and repeat customers, with an emphasis on new.

We estimate that 1H21 online sales (cA$60m) represents a similar run-rate to that achieved in 2H20 (when stores nationally were closed for c5 weeks). Therefore, the incremental performance is coming from in-store, highlighting the importance of the group’s omnichannel model – particularly in this category.

1H21 guidance well above expectations

Gross margins continue to be well above the pcp (tight inventory position + materially less promotional activity), while significant operating cost leverage also resulted on the elevated top-line outcome.

ADH provided 1H21 guidance for: revenue A$235-245m (+35% yoy at the mid-point); and EBIT A$62-66m (+180% at the mid-point). This EBIT forecast compares to our prior 1H21 expectation of cA$58m.

Upgrade FY21 by 15%, thereafter by c4%

We have upgraded our FY21 EPS forecast by c15%, while our FY22/23 forecasts lift more modestly (+4%). We now forecast FY21 EBIT of A$97m (+60% yoy), split A$64m/A$33m, implying 1H/2H21 growth rates of 136%/14% respectively.

We note the 2H21 will not see any benefit from JobKeeper. We see upside risk to our 2H22 forecasts – largely relating to GM and opex leverage. We estimate Mocka is currently run-rating +A$60m of revenue and A$14m of EBIT, despite suffering from a sub-optimal inventory position.

We still see big upside potential in this business as brand awareness continues to build and investment is made (stock, resources, etc).

Add rating maintained and updated price target

ADH has been a major beneficiary of the domestic consumption tailwinds brought about by COVID. The group has executed well on product, attracted new customers and taken market share. Retaining these new customers will be key for when demand ultimately normalises.

The enduring benefit of these tailwinds can be seen in ADH’s strong balance sheet, providing flexibility for additional growth avenues in time. Add rating maintained; updated price target (login to view price target). Based on our current FY22 forecasts, ADH is trading on <10x and 7% yield.

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