ASX code: NCK
Share price: $4.10
Industry: Cyclical Consumer Products
Forecast FY2016 Dividend: 19.0 cents fully franked
Nick Scali is a high quality small-cap retailer with a strong brand in the premium furniture market and growth from a store rollout program. The recent interim result was well above market expectations, demonstrated pricing power and came with earnings guidance which should be met given solid earnings visibility for management. Over the last five and 10 years dividends per share compounded at 11 and nine per cent per annum respectively. The 2016 dividend yield at $4.10 is 4.6 per cent fully franked.
There was much to like about the 2016 interim result. 32 per cent sales revenue growth to $103m came from very strong 12 per cent same-store sales growth over the previous corresponding period and seven new stores, taking total store count to 48. Operating costs were managed lower and profit margins expanded significantly.
Nick Scali demonstrated impressive pricing power by passing on the higher inventory costs of the lower Australian dollar, minimising volume declines in response and holding gross margins steady. There was also a strong contribution to sales growth from new stores, particularly in Western Australia, which performed well despite weaker incomes and house prices due to the mining downturn. This suggests successful execution of the entry to the WA market, a favourable competitive environment and good judgement by management to choose to expand into WA.
The store rollout should continue to drive growth. A further four to six new stores are slated for the year ahead towards a long-term target of 75 stores in Australia and New Zealand. Cost benefits are expected from a new, larger and more efficient NSW distribution centre in 2017.
The earnings guidance for the second half is conservative and management has good visibility on sales 10 weeks out due to orders and deposits taken 10 weeks before delivery and sales accrual. Currency exposure is hedged six months out, which further increases earnings visibility.
The business is relatively less affected by digital disruption as consumers prefer to sample premium furniture in a showroom. The website enables shoppers to do pre-purchase homework and drives leads for showroom salespeople.
The direct shipping model is a cost advantage. Nick Scali ships directly from its distribution centres to the customer without the need to transport stock to the showroom first. This reduces transport costs, inventory and working capital.
The Scali family has managed the company for over 50 years, and this is likely to continue under the next generation. Investors are advantaged when management has significant ‘skin in the game’ as majority shareholders (the family owns 50 per cent). Under this management structure, the company has notched up impressive financial performance.
Nick Scali’s impressive growth and financial performance in the first half were typical of the longer-term record. Over the last five years shareholders’ equity doubled with no equity raisings. The dividend payout ratio was sensible and growth has been funded entirely from retained earnings.
We value Nick Scali at $4.91 in FY16 rising to $5.92 in FY17. Upside risks include higher than expected sales and margins from a faster store rollout, improved retail trading conditions from higher consumer confidence, and a stronger than expected Australian dollar.
Downside risks are increased competition reducing prices and gross margins, a cyclical downturn affecting discretionary spending, a lower than expected Australian dollar and poor execution of the store rollout. The downside risks to consumer confidence to buy premium furniture centre on house prices, wages and unemployment.
Written by David Walker, Analyst