Adairs: Tough crowd

About the author:

Author name:

By Josephine (Jo) Little

Job title:

Senior Analyst

Date posted:

27 October 2020, 3:15 PM

Sectors Covered:

Consumer Discretionary, Industrials & Developers

• All sales trends showed an acceleration from the August trading update, persisting at elevated levels (total Adairs sales +22% and Mocka +48%).
• Gross margins are tracking well ahead of prior market expectations, benefiting from less promotional requirement and a lower inventory position.
• Operating costs remain well contained, thereby creating the backdrop for significant opex leverage in the 1H at least.
• Despite a pretty exceptional update and material EPS upgrades (c19% in FY21), the share price declined which we can only assume reflects unease with how long this strength can persist, amongst other things (eg broader sector rotations).
• Our response to this fear is that current earnings levels are not being capitalised at onerous levels (10.8x FY21, 6.6x EBITDA and 6% yield) and Adairs (ASX:ADH) continues to trade at a large discount to peers. The group will also exit 1H21 in a comfortable net cash position, creating ample flexibility to pursue other growth avenues.
• Add maintained. Login to view target price. 

Sales trends accelerate further

Adairs (ASX:ADH) issued a strong trading update as part of its AGM with all sales rates accelerating vs the August (6 week) update.

Key sales highlights: Adairs total sales +22%; Adairs LFL store sales -0.6% (or +17% excl. Melbourne); Adairs online sales +134%; and Mocka sales +48%.

Like all retailers, in-store sales have been heavily impacted by the mandated Melbourne lockdowns, but pleasingly all other markets accelerated at strong trends.

Online sales penetration was 41% in the period, obviously accentuated by Melbourne restrictions but still elevated vs other omni-channel peers.

Margin strength a highlight

The biggest surprise of the update was the strength seen in gross margins - +600bp in Adairs and +150bp in Mocka.

Clearly a sub-optimal inventory position (now rectified) has benefited margins in addition to materially lower promotional activity.

GM performance is expected to moderate from current levels (largely in 2H21 in our view).

ADH also noted that operating costs continue to be well contained, despite a focus on marketing/customer acquisition.

We therefore see no reason why strong opex leverage doesn’t flow through at least in 1H21. Following the closure of 2 small stores in the period, net openings in FY21 are expected to be 2-4.

Another round of earnings upgrades

We upgrade our forecasts by 19% in FY21 and 7-8% in FY22/FY23.

Given the strength in sales/margins and imminent re-opening of Melbourne, ADH is set to report strong growth in 1H21 (>100%).

How 4Q21 and 1H22 pan out is clearly highly uncertain at this point which we have attempted to reflect in our forecasts.

We now forecast FY21 EBIT (pre AASB16) of A$84m, with a large 1H growth skew.

Add maintained

ADH is trading on c10.8x FY21F PE, 6.6x EBITDA and offering a ~6.3% fully franked yield, based on our pre-AASB16 forecasts. We acknowledge the elevated demand for homerelated products resulting from COVID and that this will have to be cycled in c6 months time.

However, we are also comfortable that current earnings aren’t being capitalised at onerous levels. Add rating maintained (login to view more).

Key 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
• Increased competition

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