Adairs: 1H23 earnings - Supply chain reaction
About the author:
- Author name:
- By Alexander Mees
- Job title:
- Co-Head of Research and Senior Analyst
- Date posted:
- 21 February 2023, 7:00 AM
- Sectors Covered:
- Gaming and Retail
- Sales at Adairs (ASX:ADH) and Focus were better than expected, leading to 1H23 group revenue 5% higher than forecast. Logistical difficulties at the National Distribution Centre raised costs by $5m. This, combined with ongoing underperformance of the online business, Mocka, resulted in 1H23 EBIT 11% lower than forecast.
- We have lowered our FY23 EBIT estimate by 8% to $73m, which captures the 1H23 earnings shortfall and some ongoing impact from the supply chain issues in 2H23. ADH reduced its guidance from $75-85m EBIT to $70-80m.
- We retain a Hold rating and lower our target price to (login to view).
ADH performed well at the top-line, reporting 34.1% growth in sales, 5.1% above our forecast. Sales growth was driven mainly by the acquisition of Focus on Furniture. Excluding Focus, group sales growth was +6.7%, but, within this, the Adairs brand performed well, growing its sales organically by 13.1%, 7.1% higher than our forecast. T
he group gross profit margin was down 380 bps to 53.0%, but was broadly in line with our forecast. Despite all this positivity, underlying EBIT rose by only 7.9% to $35.5m, 11.0% lower than we had expected.
The shortfall arose mainly from operational inefficiencies at the new National Distribution Centre (NDC) and a sales and earnings shortfall from the struggling Mocka ecommerce business. Operating cash flow was strong and debt under control.
ADH lowered its EBIT guidance for the full year (FY23) by $5m, moving from $75- 85m to $70-80m. The sales guidance was unchanged at $625—665m.
Given the 1H23 EBIT was nearly $5m below expectations, this implies some confidence in the ability of the business to overcome the issues with the NDC and to continue to deliver a resilient trading performance despite an increasingly difficult consumer environment.
Morgans comment #1: The NDC issues appear to be on the mend
If ADH hadn’t been hit by $5m worth of problems in its new NDC, its 1H23 EBIT would have exceeded our estimate by 2%. The NDC is operated by DHL. The ramp-up of the NDC saw significant issues arise around productivity, which led to operating inefficiencies and necessitated the use of temporary warehousing space.
ADH has negotiated a new pricing arrangement with DHL that will see it make 20% savings on variable costs per unit. In our opinion, this may better align the interests of DHL and ADH to achieve optimal operating efficiency.
ADH indicates a number of practical changes have been implemented at the NDC and performance has already improved.
Morgans comment #2: Mocka disappoints again, but the worst may be over
Mocka’s 1H23 EBIT contribution was down $5.4m (95%) to just $0.3m. This was a sequential improvement on the $2.0m EBIT loss in 2H22, but fell well short of our estimate of a $2.0m EBIT profit.
Mocka experienced significant issues with product delivery and quality in FY22 and trading in 1H23 reflects the need to clear excess inventory at discounted prices following these issues.
Conversion rates are improving, however, which suggests that Mocka may be beginning to regain customer confidence. Though web traffic remains subdued, it has picked up in recent months and we forecast a better EBIT contribution of $3.5m in 2H23.
Changes to earnings estimates
We have lowered our pre-AASB 16 EBIT estimate for FY23 by $5.9m (8%) to $72.6m, which sits towards the lower end of the updated guidance range. Our estimate changes capture the $4.4m EBIT shortfall from the 1H23 result and lower our 2H23 estimate by $1.5m.
The reduction to our EBIT forecast is the net result of a 1% higher sales forecast, a 10 bps lower gross profit margin and an increase in the ratio of costs of doing business (opex) to sales from 30.0% to 31.1%.
ADH says trading is increasingly ‘choppy’ and there are indications that customers are more actively seeking a good deal when they come into store. This suggests the trading environment is likely to become increasingly challenging as the year goes on.
Some of ADH’s businesses (notably Focus) may benefit from a ‘trade down’ effect, but we believe these circumstances create elevated risk of earnings disappointment. We remain on Hold for now.
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