Adairs: The story is better than what the multiple suggests

About the author:

Josephine (Jo) Little
Author name:
By Josephine (Jo) Little
Job title:
Former Senior Analyst
Date posted:
23 August 2021, 7:30 AM
Sectors Covered:
Consumer Discretionary (Retail)

  • A very strong period of growth in FY21 (EBIT +97%) with heightened demand for ADH product, material GM expansion and opex leverage.
  • ADH’s early FY22 experience is in line with most retailers who have reported todate, as store closures impact in-store sales, partially offset by online growth.
  • There remains a lot to like about this investment case: 80% of sales coming from loyal Linen Lover members; GLA growth via new stores and upsizing; DC cost efficiencies to flow from 2QFY22; and 37% of sales online (inflated in FY21 by lockdowns) combined with a highly profitable store network.
  • We acknowledge that earnings risk is more elevated currently given ST lockdown activity (and how long this persists for). However, we see enough safety in what is one of the cheapest valuations in the sector.
  • Upgrade to Add (from Hold).

FY21 result – EBIT +97%

ADH grew sales by 29% in FY21 (Adairs +18% and Mocka +51%) while material GM expansion (+410bp; Adairs +520bp) and opex leverage (CODB -410bp) saw EBIT growth of 97%.

Mocka was the only disappointment with 2H margins falling materially hoh due to a lower GM (supply chain challenges) and investment (talent and marketing).

The Linen Lovers powerhouse continues, accounting for 80% of total sales. There are just shy of 1m paid up Linen Lover Club members who typically spend 1.5x that of a non-member.

ADH exited FY21 in a A$26m net cash position (pro-forma net debt position of A$20m after Mocka earn-out payment payable in September). Despite a strong financial position, ADH declared a much lower final dividend than expected with the FY payout ratio of 60% of stat.

NPAT (50% of normalised) - at the bottom end of its target range (60-85%). We expect this reflects the current uncertain trading environment with a large portion of its store fleet closed. We think the payout will lift back up from FY22-end.

Outlook – lockdowns bite in the short term as expected

ADH’s sales in the first 7 weeks of FY22 are cA$7m below the pcp. Adairs sales are -16% with in-store sales -27% (despite 40% of trading days lost), partially offset by online lifting 13%. Excluding store closures, Adairs’ LFL sales growth is +2.9%. Mocka sales are +16% YTD. The underlying health of the business is strong with group LFL sales +5.2% (excl. store closures), despite a strong base being cycled.

With higher stock levels and some cost inflation, the group’s GM has moderated as expected yoy. However, it remains well above FY20 levels. ADH expects to retain around half of the FY21 GM step-up in FY22.

Forecast changes

We lower our EPS forecasts by 6-7% in FY22/23/24. Clearly the longevity of lockdowns will be a key determinant of short-term earnings and therefore earnings risk is more elevated currently.

Our DPS forecast has declined by more than EPS as we assume a lower payout ratio of 60% in FY22 (in line with FY21). We think this is at least likely for the interim FY22 dividend. Should restrictions ease and demand rebound as per recent experience, we think this payout will lift quickly.

We now forecast A$57.7m NPAT (pre-AASB16) in FY22, -23% yoy.

Investment view

We upgrade to an Add rating (from Hold) with a new PT of (login to view). Despite EPS revisions in FY22, ADH is one of the cheapest retailers in the sector (CY22F PE of <10x).

ADH has a strong BS, loyal customer base and various growth options. There is of course a question mark over whether elevated GMs are sustainable long term, like most retailers. However, at this valuation, we see enough safety in the numbers.

Risks

COVID-19; material deterioration of the AUD; softening LFL sales growth (softer consumer spending/housing market/more difficult comps to cycle); product execution; excess discounting; and increased competition.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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