Adairs: FY22 Earnings - A shocker at Mocka

About the author:

Author name:

By Alexander Mees

Job title:

Co-Head of Research and Senior Analyst

Date posted:

23 August 2022, 7:30 AM

Sectors Covered:

Gaming and Retail

• At the group level, ADH’s FY22 pre-AASB 16 EBIT of $76.4m was in line with expectations (MorgansF: $77.3m). The composition was somewhat different, with a strong maiden contribution from recently-acquired Focus on Furniture making up for a poor performance by Mocka.
• Adairs (ASX:ADH) expects to ‘continue to grow sales and EBIT’ in FY23 and had the confidence to provide sales and EBIT guidance. Our EBIT estimate was at the top of the range and we have reduced it by 7% and now sit below the mid-point. Our estimates assume a partial recovery by Mocka, mainly in 2H23. We assume (3)% LFL sales decline in the Adairs and Focus banners.
• We have kept ADH on a HOLD rating despite today’s 14% share price decline. Our target price falls from (login to view) due to the changes to our estimates.

Event

FY22 earnings.

Analysis

Confident enough to give guidance at this early stage of the year. ADH was the first retailer in our coverage universe to issue profit guidance for FY23. Our previous estimate for pre-AASB 16 EBIT was $85m, at the top of the $75-85m range guided to by the company today, and we have subsequently lowered our forecast by 7% to $79m.

Nonetheless, we see it as a positive that ADH has enough confidence in what’s it’s seeing on the ground, and its own control of costs and investment spend, to provide guidance at all.

Having moved into the new NDC at last, saving it $6m of elevated opex that was incurred in FY22 will help. Perhaps there is an element of conservatism in the guidance range, although we do think there is much work to be done at Mocka to restore that business to its proper earnings capacity.

Problems at Mocka. An EBIT loss of $2m in 2H22 was a poor outcome for Mocka. The business ran into delivery delays in 1H22, the after effects of which were felt in 2H22 and compounded by product quality issues that led to extra costs of remediation.

The opportunity has been taken to overhaul the management team and write down stock by $1.2m. It seems likely to us that Mocka’s earnings will continue to be suppressed in 1H23, but we’d expect a return to margins in 2H23 that get closer to its historical performance. 

But Focus made up the difference. Focus on Furniture delivered $17m in pre-AASB 16 EBIT in its first 7 months in the group, $10m more than we had expected. When it was acquired, ADH warned that the earnings of Focus would fall away quickly.

The decline has not been as rapid as feared, allowing ADH to hit market expectations for FY22 despite the problems in Mocka.

Forecast and valuation update

ADH issued guidance that it expects FY23 sales in the range $625-665m. We have trimmed our estimate by 1% from $649m to $643m. ADH also gave guidance for pre-AASB 16 EBIT of $75-85m. We have lowered our estimate by 7% from $85.3m to $79.2m.

Our FY23 pre-AASB 16 EBIT estimate comprises Adairs $52.0m; Mocka $6.7m; and Focus $20.5m.

FY23 will include an additional 5 months of Focus and will not see the recurrence of $6m of elevated operating expense caused by the need to keep a legacy distribution centre open while the new NDC was being ramped up.

Our DCF and EV/EBITDA-based target price falls from (login to view).

Investment view

We downgraded ADH from ADD to HOLD back in early July, concerned about the risks to earnings from a decline in consumer spending and we maintain that rating today.

Consumer demand for the company’s products is, in our opinion, likely to see a negative impact from rising interest rates and reduced real household income.

The dividend yield is attractive, however, and we believe the company can continue to distribute around 60% of its earnings while paying down debt. We note FY22 ND/EBITDA was 2.2x. We forecast this to fall to 1.6x by June 2023.

Risks

• Risks includes a sharper than expected fall in consumer spending and inability to restore customer confidence in Mocka.

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