Furniture retailer Nick Scali (ASX:NCK) reported its full-year results, and on most measures, the results were in line with consensus estimates. However, there were some surprises, in which an understanding of the nuances led to a reasonably optimistic conclusion for this A1 quality company.
Total revenue of $468 million (down 7.8 per cent year-on-year) and net profit after tax (NPAT) of $82 million (down circa 20 per cent) for FY24 did not surprise. The FY24 results were cycling peak sales last year, which benefitted from a COVID-19-related backlog of orders being delivered (the company records revenue when items are delivered, not when ordered). The result also included UK written sales orders of $8.1 million from 8 May 2024 (more about the UK acquisition in a moment).
What did surprise was the significantly higher-than-expected gross margin of 66 per cent for the Australian business and a softer outlook for trading activity and new stores.
Perhaps unusually for a retailer with a June 30 year-end, Nick Scali, this year, combined June and July activity in its trading update. The combined Jun-Jul written order growth for Australia and New Zealand, however, was negative -1.2 per cent compared to the previous corresponding period. The result was softer than analysts had predicted; however, the result was almost entirely due to New Zealand’s four or five stores, which were down 35 per cent. Australia was flat and relatively stable. Keep that in mind as you read on.
It’s also worth looking carefully at the July-June combination again. June 2024 benefited from five weekends of trading (one more than the previous year), whereas July was disadvantaged by one less weekend when compared to the 2023 calendar year (70 per cent of sales are generated on weekends). Why is this important? In addition to one less weekend in July, the press was also reporting on the possibility of interest rate hikes here in Australia. That influences consumer sentiment. Since then, we have seen the narrative shift to rate cuts. Keep that in mind, too, as you read on.
It’s also worth remembering that June sales are a meaningful contributor to annual results, while July is not.
Over in the UK, the acquisition of furniture retailer Fabb is entirely strategic. Australian analysts were very excited at the company’s announcement of its HY24 results when Nick Scali demonstrated the benefits of scale that came with the acquisition of Plush in Australia. Greater scale means more buying power, which is especially useful when Chinese manufacturers are rattling the tin to win more business as their domestic economic growth rates plunge.
The UK business has a large network of stores conveniently located in ‘homemaker’ centres near some of the largest players in the UK market. The addition of Fabb to the Nick Scali network, not only means better buying in the UK thanks to Scali and Plush in Australia, but the reverse is also true. Adding the UK business should result in better buying locally.
UK conditions were challenged last half by longer lead times due to supply chain disruptions; however, the upside to sales volumes in the UK comes from declining interest rates. We note the Bank of England has already cut rates once.
Tuning to the domestic business and remembering Australian sales were stable during the half, even as talk of rate hikes dominated conversations among consumers, the possibility of rate cuts locally provides a material upside option to trading activity. One can imagine that as rates begin to fall here in Australia, the Australian Nick Scali and Plush businesses could begin to grow again, and off a higher base.
For the Australian and New Zealand operations, the more recent fourth-quarter sales orders of $121.2 million were up 4.8 per cent on the prior corresponding period. Importantly, however, June had five weekends compared to four last year, while July had one less weekend. Weekends are important because nearly 70 per cent of the company’s revenue-generating activity is generated on weekends.
Nick Scali’s surprisingly strong underlying 66 per cent FY24 gross margin for Australia and NZ was well ahead of consensus estimates and was up 250 basis points year on year, with none of the usual caveats about shipping and freight costs other than Nick Scali suggesting elevated rates will prove short term. The shipping industry is reporting a rise in recent freight costs due to Chinese demand for containers as that country dumps its electric vehicles (EVs) on the European market before imminent new tariffs on Chinese EVs are applied. The absence of any commentary suggests Nick Scali has not been impacted materially.
The second half of FY24 continued to benefit from the structurally improved buying scale from the Plush acquisition. Margins were also helped by the aforementioned tin-rattling of Chinese manufacturers (see below), and while this may be cyclical if China’s domestic economic growth begins to accelerate, the group should benefit from the greater buying power that comes from the UK Fabb acquisition. The company believes it can maintain gross margins of 64-65 per cent.
Elsewhere, Nick Scali’s online business saw written sales orders jump from $29.5 million in FY23 to $34.8 million in the last financial year.
Anticipated new store openings have disappointed slightly. The consensus expectation was for a total of 68 Nick Scali stores to be operating in FY25; however, the company has indicated that number will be 66. Meanwhile, analysts had expected 52 Plush stores, and the company has guided to 48 stores in FY25. The company’s long-term targets, however, remain unchanged at 86 Nick Scali stores and 90-100 Plush stores.
An optimistic, but not overly optimistic, appraisal would suggest Nick Scali management might be more focused on the benefits of getting the UK business right, a business that resides in a much larger market and could deliver substantial gross profit margin benefits to the entire group. Indeed, the company noted its focus is on refurbishing stores on the fringe of London before introducing and marketing Nick Scali product and then moving to the remaining stores.
Nick Scali’s shares have outperformed the market materially (+15 per cent) in the last month. On a price-to-earnings (P/E) of roughly 15 times earnings, the shares do not appear to be priced like a growth stock. However, the shift to a lower interest rate world (remember, Australian sales were flat in June/ July despite talk of rate hikes) could result in substantial revenue growth. The UK will lose money this year but the price does not reflect anything for the growth that could emerge in this much larger market, nor the contribution to margin from scale the UK will deliver if the company’s execution of its Plush combination is repeated in the UK with Fabb.
The Montgomery Small Companies Fund owns shares in Nick Scali. This article was prepared 12 August 2024 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Nick Scali, you should seek financial advice.