Why profits are up but share price is down at Nick Scali
Furniture importer and retailer Nick Scali (ASX:NCK) receives a Quality score of 99/100 based on Stockopedia's Quality ranking system. This means it is in the top 1% of all companies listed on the ASX based on a combination of quality metrics.
Nick Scali was established more than 50 years ago by the Scali family and listed in 2004. They raised $40 million in the IPO and have never raised any equity capital since.
During its listed life, earnings per share (EPS) has grown from 9c to $0.93, an annual growth rate of 14% over 18 years. The share price has increased from $1.00 to $10.33 today and they have paid out $4.275 in dividends. $10,000 invested into the IPO and held, would have yielded almost $140,000 in profits or an annual compounded return of 17.1% per annum.
This demonstrates how investors can accumulate large amounts of wealth by investing in high quality companies, and then remaining patient despite the gyrations caused by pandemics, property cycles, exchange rates and share market sentiment.
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. But unlike many other retailers, Nick Scali's revenue growth continued into 2022 and further growth is forecast for 2023 following a record first half.
However, a direct comparison is not entirely fair as Nick Scali's revenue growth was not all organic. It includes revenue from Plush-Think Sofas which they acquired in November 2021. Plush added another 45 furniture stores to the 62 under the Nick Scali brand. 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 was not expensive.
Unlike many acquisitions this one is looking like it will add significant value to Nick Scali shareholders. They have already managed to strip out $20 million in running costs, benefits that go straight to the bottom line, as well as paying off $17 million in debt.
On Monday Nick Scali released their 2023 financial year half-year results. Revenue hit a record at $284 million for the half. Net profit was also up 70% to $61 million. Only two months of income from Plush were included in the previous period, versus the full six months this half year. The first half of last year also included extended periods of lockdowns in the eastern states.
Nevertheless, it is still a very strong result. Gross profit margins also rebounded to 62% helped by reductions in freight costs that had skyrocketed during the height of the pandemic. They have also seen big improvements in the gross margins at Plush as processes have become much more efficient.
Typically Nick Scali earns a little over 50% of its revenue in the first half, although the last few years have not been typical. If this held true, they could expect to earn about $560 million in 2023. Market analysts were forecasting full-year revenue of $537 million prior to the release of the results, so there is room for some upside to these expectations. Since the results announcement, some analysts have already started making small upgrades to their EPS forecasts.
Despite this seemingly strong result, the share price fell 13% on announcement day and a further 4% the following day. Which begs the question, why?
Admittedly the market as a whole also fell, but not nearly as much. It would appear that the declines were driven by a shift in sentiment regarding the outlook for the remainder of this financial year. Management expressed concern that rising interest rates may start to dampen demand, but so far they were not witnessing it.
Some of the commentary from the presentation of the results included that Nick Scali brand sales orders declined 3.0% but this is in comparison to the boom times of 2021. Further, written sales orders for January were 12.1% below January 2022. This includes prices reductions of 5% to 10% in January. Management expects price reductions across the industry. In part, this reflects the capacity to pass on some price reductions due to the benefits of the appreciating AUD, but the market probably also interpreted it as a sign that demand is softening. They also declined to give full-year guidance, citing uncertainty about the coming months.
There is no doubt that some pressure is building as interest rates rise and property prices fall, however, Nick Scali has ridden through many cycles in its history and has demonstrated it can come out the other side in good shape.
From a valuation perspective, some of the metrics are starting to look attractive following the price retraction. The forward PE ratio is only 9.2 which compares with a five-year average of about 13. The dividend yield is 7.6% fully franked.
The short-term risks for Nick Scali are heightened as the uncertainties around inflation, interest rates, the property market and the economy remain. However, the company is conservatively managed and has an outstanding track record of steady growth over the long term. The value proposition for the shares is much like that of Nick Scali's lounges. A quality product at a reasonable price.
Disclaimer: The author has holdings in NCK
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