Are Dusk shares burning out or is there light ahead?

Dusk (ASX:DSK) is a retailer of candles and other home fragrance products.

It designs its own products and sell them through its network of stores as well as online. They are not sold through other stores or market places.

Candles are their biggest product however 64% of sales come from other products with diffusers and scented consumable refills rapidly catching up to candles.

Dusk underwent an IPO in November 2020. The price soared from $2 to $4 in the first eight months but then began a steady decline.

The driver of this initial growth was strong sales during the pandemic which resulted in four trading updates during their first six months as a listed company, each revealing a further improvement in results.

Revenue hit $149 million in 2021. It is anticipated that revenue will be $140 million in 2023, a decline of 6% from the peak, but still 40% higher than in 2020. The pandemic led to a trend where people were spending more money sprucing up their homes.

Things have largely normalised now with travel and entertainment back on the agenda, but Dusk has managed to lock in a large portion of the gains made during that unusual time.

It is continuing to grow its store network which numbered 141 as at December 2022. It opened nine stores in the first half of FY23 and is aiming for six more in the second half. Online sales accelerated during the pandemic to 8.3% of total sales but have now retracted to 5.6%.

Dusk is a profitable business.

Profits grew very strongly until 2021. In 2022 it eased back a bit and the first half FY23 results revealed it has come under more pressure this year.

Gross margins declined by 1% due to increased promotional intensity and unfavourable currency movements. General overheads, referred to as Cost of Doing Business (CODB) by retailers, rose 16% driven by new store openings, higher wages and inflation.

This was distorted somewhat by lower than usual CODB in 1H FY22 when stores in NSW, VIC and QLD were closed for extended periods and staff stood down. Net profit for the half declined by 9.5% to $13.3m but that still represents a very healthy net profit margin of 15.5%.

The downturn in sales continued into the first seven weeks of 2023.

The softening macro environment is creating uncertainty, with 'outside store traffic' noted to be 6% lower than the previous corresponding period. Don't forget that the same period last year was when the Omnicron variant of Covid was ripping through the land, so that was a quieter than usual period itself.

The fact that Dusk have managed to maintain strong profit margins despite the cost pressures contributes to their excellent Stockopedia Quality score of 91. The returns on equity of 40% and return on invested capital of 34% are very high and they are being achieved without the use of leverage.

The Health Trend as measured by the Piotroski F-score, which looks at the movement across profitability, liquidity, and efficiency, is a healthy 6 out of 9.

Using the Altman Z-score to measure Bankruptcy risk returns a very safe measure and the Earnings Manipulation Risk as measured by the Beneish M-score is low.

Like most retailers, Dusk receives cash at the point of sales, so sales and profits translate directly into strong cash flow.

It also has a very healthy balance sheet and at the end of December it had cash of $32 million and no bank debt.

In the short term, the current macro environment may see pressure on sales and margins. However as we have seen, whilst revenue and profits have declined from the bumper levels witnessed during the pandemic, it is still very healthy.

Looking to the long term we can try and assess a company's likely sustainable growth.

To do this we focus on retained earnings and a company's ability to fund long-term growth from retained earnings. Such a business is more likely to have a competitive advantage.

Dusks funds its growth from retained earnings rather than using debt or raising additional equity capital.

Shares on issue have remained constant for the last six years and that includes their IPO where existing shareholders sold down their stakes, but new capital was not raised. The company now has a broad base of shareholders with no one shareholder having more than 5% of the stock.

CEO Peter King, has steered the ship since 2014. He has announced his intention to step down in August 2023. Last week it appointed Vlad Yakubson, currently general manager of menswear retailer, yd (part of Retail Apparel Group), to take over the CEO role.

In addition to the high Quality score, Dusk represents a strong value opportunity. The forecast PE ratio is only 7.6 and the forecast dividend yield is 8.5%, fully franked. The other value metrics are also strong including Price to Free Cash flow and EV to EBITDA.

Stockopedia classifies Dusk as a Contrarian stock. This means investors need to be mindful of the near-term headwinds, but for those who see a bright future on the other side of those, then Dusk may represent a sweet-smelling opportunity.

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