Why you should consider furnishing your portfolio with Nick Scali

It has been four years since I last wrote about furniture importer and retailer Nick Scali (ASX: NCK). I commented then, that over the last 12 months they had produced a return of 16%, including dividends, and over the past three years, 188%.

Today, the comment would be 32% over 12 months and 165% over three years. Put simply, it is a business that keeps on delivering, despite pandemics, bushfires, and property, exchange rates and share market gyrations.

Nick Scali was established more than 50 years ago by the Scali family and listed in 2004. It has raised $40 million in the IPO and has never raised any equity capital since.

During its listed life, earnings per share (EPS) has grown from 9c to $1.04, an annual growth rate of 15.5% over 17 years. The share price has increased from $1.00 to $13.45 today and it has paid out $3.575 in dividends. $10,000 invested into the IPO and held, would have yielded $160,000 in profits or an annual compounded return of 18% per annum.

This demonstrates how investors can accumulate large amounts of wealth by investing in companies that are run really well and then remaining patient.

Selling furniture may not seem as exciting as some of the 'change the world' tech stocks that are available, but excitement and profits do not always go together. (Although sometimes they do and spectacularly so.)

In the 2021 financial year, Nick Scali, like many retailers, saw revenue grow at record rates as people were restricted regarding travel and going out, so they diverted their spending to sprucing up their homes.

This was enhanced further by generous amounts of government stimulus spending and rapid growth in property prices. Revenue grew by 42% and earnings per share more than doubled. Net profit margin hit a record at 22.5%.

This was not really expected to continue into 2022 as the circumstances were fairly exceptional. Add to that the COVID delta lockdowns of July to October 2021 and the Omicron shadow lockdown of January 2022 and store foot traffic has been considerably reduced. Nick Scali stores saw written sales orders fall by 10% during the first half of 2022.

In addition to the lockdowns impacting customers' store access, a bigger impact was felt by lockdowns in supplier countries, especially Vietnam. With suppliers subject to COVID lockdowns, lead times for delivery blew out as lounges are made to order, but this did not dampen customers' propensity to order.

Similar delays were being experienced across the industry, as well as many other industries, so customers had come to accept it. However, the outstanding order bank has continued to grow and the online business has also performed strongly. These delivery delays have largely been resolved, for now.

Overall, the performance in the first half was solid given the COVID induced challenges. The outstanding order bank at the end of January was 70% higher than the previous year, and with lead times from suppliers now back to normal, this will translate into revenue in the second half.

The other big change during the first half was the acquisition of Plush-Think Sofas. This resulted in a 75% increase in the store footprint. The acquisition was funded through debt and existing cash. The purchase price of $103 million represented an Earnings before interest tax, depreciation and amortisation (EBITDA) multiple of 3.8 which is inexpensive and expected to add to EPS immediately. Add to this the synergy opportunities between the two businesses and it should prove to be a good boost to profit growth.

Nick Scali also has a property portfolio of 10 properties worth about $100 million. These properties are used as showrooms and distribution centres, reducing the risks associated with leasing. This is fairly unusual for a retailer.

Looking forward, the immediate challenge is with shipping costs. There is a lot of uncertainty as to what they will have to pay for freight over the coming months. While they are able to increase prices to cover increased freight costs, there is a delay, so price increases put through today may be insufficient to cover freight charge increases in three months' time. Thus there is the possibility of a negative impact on margins in the short term.

The share price has risen 16% over the past 12 months and has actually retracted 17.5% from its November highs. It is up over 400% from its March 2020 lows. Despite this strong growth the share price does not look overvalued. It is trading on a PE ratio of 14.6 based on consensus EPS forecasts for 2022. Those forecasts could prove to be conservative as they do not make much allowance for the potential benefits to be gained from the Plush acquisition.

A PE of 14.6 compares with the five-year average of 13.3, but Nick Scali is now a larger business able to access benefits of scale. At these levels it is being priced as a business with minimal growth prospects, but as demonstrated above, it has found a way to grow revenues and profits at mid-teen rates for long periods of time.

The forecast dividend yield is 5.2% fully franked.

A company that can increase earnings by 15.5% p.a. over 17 years, while paying out about two-thirds of earnings as dividends, and reinvesting the rest, without ever needing to raise capital and making minimal use of debt, may be worthy of consideration.

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