I like ADH, I do, but not in todays external climate and the Mocka Goodwill write off which is surely coming.

Here are my 8 reasons why I have retreated to the sidelines awaiting the recessionary pressures to abate.

(1)   Inflationary effects on domestic household budgets

(2)   Higher costs of servicing household interest burden driven by (a) increasing interest rates to date and likely continuing into the future (b) massive interest rate increases by the rollover of previously fixed rates at around 3% to close to 6% - massively increasing over the next six months (c) Strict APRA rules on ensuring new loans be stress proofed at 3% over current home loans rates of around 6% will restrict the volume and quantum of future loans

(3)   Falling domestic dwelling construction (April 2023 down 8.1%) and liquidation problems in this industry presently. Adairs is a beneficiary of the need for hard and soft furnishings in these new dwellings 

(4)   Effective increase in wages by 6.25% by Fair Work Commission (June 2023) will push ADH wages as a percentage of sales from 19.4% to 20.6%. Sure I do understand that Ronan will look for greater productivity.

(5)   Current hedging at around 72c USD will run out end of year and the direction of the AUD/USD is likely down – currently 66c 

(6)   The diabolical performance of Mocka – a likely FY23 EBIT of ZERO on an asset with a book value for goodwill and brand of around $72m – the results get worse each six months and the company has now had 4 half yearly time periods to make an improvement, instead it steadily gets worse.  

(7)   A total write off of the Mocka goodwill will take the net debt as a percentage of net debt plus equity to around 40%. Might raise the banks risk level and thus interest rate to be assessed on the $75m debt facility due to be renewed in July 2023

(8)   Very likely a partial to significant Mocka Goodwill and brand acquisition write off in FY23 or FY24 (discussions with auditors probably happening right now as already foreshadowed in the fine print to the 1HFY23 results as follows:

 “The cash flow forecasts assumed for the FY23 year reflect a substantial reduction on those applied in the previous impairment test at 26 June 2022 given the actual operating performance of Mocka for the 26 weeks ended 25 December 2022.” - And

“The above sensitivities in isolation do not result in an impairment of the Mocka CGU at 25 December 2022. However, additional adverse changes to any of the above key assumptions may result in the carrying value of the Mocka CGU exceeding its recoverable amount” Note the adverse conditions have emerged in 2h by my calculations as based on the recent trading update.  

And might I say, the NDC issues and the still to be perfected delivery system for online might well be a ninth reason.

Terrific coverage of the 1HFY23 results by other Straw people, so I will simply cover the issues which I think are potentially coming our way in the full FY23 results.

Firstly, I just cannot see how the auditors (EY a tier 1 audit company with a reputation to defend) will allow ADH to retain a $95m acquisition cost for Mocka to remain on the Balance Sheet without agitating for a substantial write down. Sure, it’s a book write down not affecting the cash position, but it could be sufficient to plunge ADH into a statutory loss for the FY23 year. Think of the market’s reaction to such an event.

The recent results for Mocka are almost trifling in their nature. Can a HY EBIT of just $300k justify an asset cost base of around $95m (that’s my estimate of the original cost including the early $45m payout in Sep 2021 to just get the original Kiwi owners out of the company)? I don’t think so. Take the interest component out of such a huge investment and this division is underwater.

The Mocka results for FY22 weren’t brilliant either – a full year EBIT of just $3.7m. Again, this would hardly cover the notional costs of the interest component against this investment. The FY22 results show ADH debt at around BBSW + 2.05%

Mocka has been a disaster and a case could be made to suggest that the cheaper Mocka product range, its poor service and delivery have affected the Adairs culture. ADH does not enjoy the 'community love' it did say 3 to 5 years ago. Goodwill has been damaged.

Yes, Ronan has been upfront about the problems in Mocka, but the simple fact is that after two years this isn’t fixed and we are a long way from a fix, if indeed the Mocka business model is survivable in its current form. TPW and KGN might suggest the online business model needs tweaking. Maybe ADH should drop kick Mocka to the sidelines and concentrate on the main game, which is the ADH brand and Focus on Furniture. And particularly store expansion of both of these which has been palpably slow. But, as anyone who has been in business knows, the wonky wheels get all the attention, to the detriment to the good solid reliable wheels.

As to the NDC, I think we can cancel that ‘centralization’ cost savings bit. If savings are coming, they are down the track, two years minimum.

Disclosure: I hold ADH IRL because the ff dividends are attractive, but I have to say I have moved part of my investment over to my favourite retailer, the Shaver Shop (SSG), which is in a much better position to stave off a decline in retail consumer spending.

Agree with posts by @Rick and @Strawman, a solid AGM presentation.

Positives

The Focus on Furniture acquisition is performing above expectations with all 23 stores profitable and with a big opportunity to roll out further stores. Foresee 50-60 stores across Australia with annual sales being in the region of $250m within the next five years

Reaffirmed guidance given the 1st 16 weeks of trading where they saw stronger consumer confidence. The next two months of revenue sales are crucial to their final result and they do believe there will be a softening of confidence in the second half.

 More solidity around the $1bn in 5 years (FY27)

Adairs            $600m

Mocka            $150m

F on F             $250m

This implies a CAGR of 12.1% - down on the CAGR from IPO of 15%, but still an acceptable/okay result.  

86% of expected USD purchases in FY23 are hedged @ 74c

 Negatives

The National Distribution Centre (NDC) is ‘performing well below expectations in the areas of efficiency and productivity and is a key focus for management going forward’. This would suggest additional costs not necessarily included in the EBIT guidance estimates and possibly additional distribution costs as only ADH stock is totally within the NDC.

 Mocka - The distribution and product issues of FY22 have been addressed operationally, but it will take longer to restore customer confidence. In FY23 Mocka is ‘focused on increasing customer confidence, restoring gross margins and ensuring a stable supply chain’. And so they should.

At the FY22 results conference MR commented that the 5.7% EBIT for Mocka will likely be 14-16% in FY23. Now got to be in doubt. Consumer confidence will be slow to return if you judge it on the ferocity and deep seated ill-will. Besides, online sales are flattening as customers return to bricks and mortar shopping. 

Margins will likely fall given that there will be a greater contribution to revenue from F on F which has lower margins than Adairs, as does Mocka.

No comment on the wind back of stock which increased by $32m in FY22.

I listened to the ADH investor discussion on 1HFY22 results & they provided some ‘colour’ (to use an ‘analysts’ buzz word) around their supply line, distribution & delivery issues which accounted for an additional $3.9 million in additional expenditure in 1HFY22 results. I was very much aware there was tremendous customer dissatisfaction and was keen to hear their POV.

 The crux of it is that (Mocka particularly), they were significantly let down by one of their large delivery suppliers. Quite possibly, there was a large element of “hiding” of the huge backlog of orders (thousands) which were sitting in the deliverers distribution centre, whereas they were marked delivered at the Adairs end.

 The company has rectified this now by appointing multiple delivering firms and has significantly strengthened the communication between ADH & the delivery agents, as well as ADH and the end customer.

They did state that when contacting the disgruntled customers by phone, whilst they were disappointed, they were somewhat understanding of the situation. ADH stated they will be working extra hard to rebuild goodwill lost & have rolled out a marketing campaign to do so. Bottom line on this issue: it is a temporary, but regrettable scenario which will be rectified in 2HFY22. That said, these costs will remain elevated in 2HFY22.

The good news is that these additional costs in FY22 will not be present in FY23 and in the second half of FY23 they will begin to recoup the estimated $3.5 million in saved costs because of the new national distribution centre.

The other significant cost blowout was of course the costs of Covid of $15m in 1HFY22. Hopefully they will be a thing of the past going forward.

In terms of growth, the one thing that caught my ear was the intention of the company to roll out a physical presence for the Mocka brand. It won’t start until FY24, but could be significant (I think I heard potential for 70 stores in due course).

Plus ADH have designs on rolling out an additional 30+ Focus stores nationally.

As Peter Lynch always stated, retail is great because it is so easy to grow by opening a proven successful concept in different locations.

Whilst 1HFY22 was disappointing, the future does look assured.

I suspect this shock announcement comes on th back of a shocker of a Xmas trade - far worse than they were envisioning. Why? Well, director Trent Peterson, one of the sharpest retailers running around, shelled out $500k at $3.60 ish on 1st December - clearly he didn't see this coming.

I agree with Strawman, the business model isn't broken, much of these issues are 'one offs' but they are BIG one offs and this report masks some of the pain by hiding behind terminologies like 'underlying EBIT" where they conveniently don't account for the costs of the Distribution Centre cock ups. When you deduct these and the costs of the Focus purchase and some costs of completing the Mocka purchase, reportable EBIT will be much lower than the $30m.

Generally ADH management are solid to good performers but they completely messed up the supply lines and delivery on their online products and the consumer backlash has been very vocal and brutal. Goodwill damage has been done as their customer service recovery was poor. EPS and dividends will be downgraded as will IV valuations. Share Clarity follows ADH closely and they have already reduced their IV from $4.76 to $4.06

But when you follow the cash, things are not doomsday. Presuming working capital requirements were static then we used up $116.6m in cash and extra debt in the six months - which can easily be accounted for as follows:

Finalize Mocka acquisition $45.7m, Cash out on Focus acquisition of $61.5m and they shelled our $16.9m in dividends - total of $124.1m - so all the extra costs on the distribution centre/s and handling of supply line and delivery problems have been covered from operational cash.

I will take a stab at FY22 eps of 19c to 22c and dividends around 14c - but be warned, my knives are usually blunt.

When you dilute the FY21 results for Focus on Furniture (FOF) for the Covid ‘sugar hit’, the real EV/EBIT multiple of the deal is around 5.7x to 6.6x – about the same as projected for ADH in FY22.

Given there have been no quantified synergies stated, though doubtless they are there in some fashion, this deal is really a straight ‘shoot-out’ between the interest paid on the bulk of the acquisition cost v the likely EBIT from this separate business. From my quick study of the Annual Return the interest rate stated on the $90m unused facility is at BBSW + 1.85% - around 2%.

Presuming FOF meet the normalized FY21 estimates of an EBIT range of between $12m and $14m over a full year (FY23 to be the first such year), then this translates into the following on a per share basis

EPS from FOF acquisition alone– 4.2c to 5.0c

Divs from FOF acquisition alone – 2.7c – 3.25c

(Note ADH have affirmed the dividend policy to pay min of 65% in divs)

Grossed up divs from FOF acquisition alone - 3.85c to 4.64c

Yep, I can live with this and take the additional growth as a bonus.

ADH under-valued or TPW over-valued?

A Tale of Two Companies

Company A & B sell exactly the same product mix in exactly the same way.

Company A is valued at $1.773bn (Enterprise Value) & Company B EV of $633m.

Company A sold $326m of goods for a GP margin of 31% and an EBIT margin of 5.92%

Company B sold $187m of goods exactly the same way (online sales) for a GP margin of 39% and an EBIT margin of 20.68%.    

What’s more, the NPAT of Company A was just $19.1m for a $1.773bn company remember.

Whereas the NPAT of Company B when you also add in its bricks and mortar trading is $63.7m!!!!

Company A is Temple & Webster (TPW) and Company B is Adairs (ADH).

Sure, there will be those who say that growth in TPW is the missing link, but let me tell you, their FY21 sales were up 85% and NPAT in percentage of revenue went backwards!

The ADH online revenue increased 31.6% and is now some 37% of ADH sales.

Bottom line: The ADH profit is 233% more than that of TPW yet TPW is valued at 180% more than ADH.

Sorry, but I just don’t see the massive divergence in value of these two companies and believe ADH to be massively undervalued by the marketplace.

A pretty solid result for ADH and yet another one for those wanting growth, plus 'real' earnings and a very healthy ff dividend. Hard to explain the recent volatility but around $3.80 I reckon this is a forwrd looking gross dividend for FY22 of 38.5c - tell me, where can you get the famed 10% return as preached by The Richest Man in Babylon!

My concerns about margin and supply have been admitted by ADH, but I am pleased about two things.
Firstly, they have acted to bolster onshore inventories - up 56% on FY20
Secondly, they have wisely hedged 75% of FY22 inventory @ 75c - so this gives us a bit of a break.

They are confident we will continue sales momentum. An 8% increase in total shop sqm in FY21 will be repeated in FY22.
Online will continue to surge. Their subscription based (admittedly peanuts to join) Linen Lover Club is nealry 1m strong and accounst for 80% of revenue. Yep, the Adairs omni-strategy is powering.
The Mocka (they bought this online biz a year ago) FY21 EBIT of $12.4m was a tad disappointing on the back of falling margins and increased marketing spend, but I think the riot act has been read in those quarters with the founders shuffled on and a new CEO appointed.

Bottom line: The Covid drama does provide ADH with a tailwind; No international travel for quite sometime sees more money spent on the home and the home office.
I can see FY22 being a better year than FY21.

Rev of $590m NPAT of $77m eps of 45c Divs 27c