Feeling good about my decision to sell Adairs (I suspect you share the same sentiment @mikebrisy)

All the results details are here, but very briefly, this is largely a story of falling margins.

Gross margins were down a full percent across the group (now at 58.6%) and EBIT margins were 3.2% lower at 10.3%.

That may not sound like much, but when you consider that revenue was 10% higher, even these declines were enough to drop operating profit by over 16%.

Of course, it's always nice to see the top line grow, but the previous year had lost trading days due to lockdowns and FY23 had a full year contribution from Focus (it only traded for 7 months in FY22).

As has been noted previously, their warehousing issues are a big part of the margin squeeze issue -- costs here were almost 17% over FY23. Higher delivery costs -- up nearly 20% -- meant that the cost of doing business was a full 15% higher. There were also higher employee costs.

Still, a 6.5% net margin aint terrible for a retailer, assuming they can stabilize that and return to stronger normalised top line growth. That's the big question here imo.

A lot of bad news was already priced into shares, but this morning we're seeing a further 11% fall (at time of writing) as Adairs said the first 7 weeks of FY24 have seen a 8.9% decline in sales and said that "the near term outlook is likely to remain challenging..".

No full year guidance, final dividend cut.

Shares on a PE of 6.7. No doubt good value if you think they can turn things around. I just think that they could be in for a very rough period and would want to see some signs that there operational issues have been resolved before i got interested again.

Things are tough in the retail..

Adairs lowers EBIT guidance (again), this time by about 16% due to falling sales.

If they hit the midpoint of this updated guidance, sales will be up 10% on FY22 (although that includes a full year contribution from Focus)

Based on this, it looks like the forward PE is around 10 or so. If the FY dividend drops back to 13cps, you have a >8% yield

Value or value trap? Had my fingers burnt on a small position with this one (sold out at around $2), and i'm increasingly wary of the current retail trading environment, so happy to watch from the sidelines for now.

Adairs reported a 34% lift in sales, but this was cycling off covid-related store closures and includes a full 6m contribution from the Focus on Furniture acquisition.

As a stand alone, Adairs sales were up 13%, but this is against a period where nearly a 3rd of trading days were lost. As people returned to physical stores, the % of online sales dropped from 32% to 26%

Container rates and delivery charges (up 41%) impacted margins in a big way for this segment. Combined with higher costs of doing business, in part to the new distribution centre having poor "operational outcomes", the operating margin dropped from 12.5% to 8.5% -- which is a lot.

All of which means that despite a 13% lift in sales, EBIT dropped 23.4%. The Adairs segment is about 2/3 of total sales.

The online only Mocka segment wasnt great either, as people returned to physical stores. Add to that the costs associated with fixing past operating issues and reduced margins due to stock clearance and overall sales were down 27% and the segment was essentially break even.

Focus on furniture was the bright spot. Now accounting for over a quarter of revenue, it saw sales lift 20%. Because of high levels of product availability, and with newer stores maturing, they also had better margins which led to a 27% jump in EBIT. It's performing ahead of expectations.

For the rest of the year, the company reiterated sales guidance of $625-665, but added delivery costs have seen Adairs lower their FY EBIT guidance from $75-85m to $70-80m (about a 7% reduction).

Results presentation here

All told, not a fantastic update. They seem reasonably candid about the issues and are obviously trying to fix them, but this is all a good reminder of just how tough retail is. And this is in a space that will be impacted by any drop in consumer spending and lower housing turnover.

The market's reaction was quite tame given the reduced guidance -- then again, shares were already down about 20% in the last few weeks alone, and the company is now trading at a 6.5x EV/EBIT multiple. The yield is 6.6% fully franked (assuming 16cps for FY).

Shares seem pretty darn cheap if you assume there are no major structural issues and they manage to avoid any material and sustained slowdown in consumer spending. Even with the expectation for reduced margin in FY23, the forward PE is probably only around 10 or so.

Even if you assume no real growth from here, something yielding 6-7% fully franked aint bad.

BUT...

The worry, of course, is that it doesn't take much of a hit to sales or cost pressures to really bugger up the margins. As an example, at current gross margins, an 18% fall in sales wipes out ALL operating profit.

You can make the argument that even if the housing market and general consumer spending falls away, so long as the business can survive, and even if it takes 3 years to get back to the current (already somewhat depressed) per share earnings of (let's assume) 24c, there's probably decent available now. But it'd be a hell of a ride.

I retain a tiny position (about 1%) but am not tempted to increase at this stage. I was lured in by what now appears to have been a value trap, and am not looking to double down on that mistake (if that's what it ultimately is) until i see some signs that they've overcome some of their operating issues and that we don't see too much of a collapse in household spending.

Adding to @Rick's Straw.

Adairs is trading below its 2015 IPO price. In the meantime, this is what the business has done:

Acquisitions have helped drive sales, but the core Adairs brand has continued to power ahead:

So why the pull back in 2022?

Partly, it was cycling super strong growth during covid which saw all of us buying more stuff online and tapping into that sweet home equity after house prices jumped some insane amount. Good times, but tricky to follow through on.

Also, Mocka had a misstep with quality issues and supply chain drama, which we can't ignore. Management reckon it's fixed, but we'll see.

Still, the trend is impressive and, taking management at their word, they hope to double sales in the next 5 years. That's through a combination of store roll outs and a growing loyalty program. Penetration seems low, so it's not unreasonable.

And as Rick has pointed out, they have had a solid start to the current year and reiterated EBIT guidance, which will be between flat and 12% higher.

But shares are on a PE of about 7 and a yield of 9.3%, fully franked.

So, what gives?

Well, no doubt the Mocka stumble has made the market a little nervous. But I dare say that there's some nervousness around the macro scenario. We are, after all, talking about a discretionary retailer whose sales are (I would suggest) very much tied to what's going on in the housing market. There's a also some debt -- $93m worth -- following the acquisitions of Mocka and FoF. This will take a few years to pay down and the cost of this debt will almost certainly rise (interest = the bank bill swap rate plus 2%). Of course, the ambitious store roll out plan will take plenty of capital.

As can be seen above, there's a good degree of operating leverage. A seemingly small change to gross margins can have an outside effect on net earnings.

All of this isn't to be overly bearish, but just to help put things in perspective.

If we were to go into a recession (and i'm not for a second suggesting we will -- but it's certainly possible), a retailer like this will hurt. Remember, the PE can rise not because the price increases, but because earnings fall.

The fact the market is trading this on a double digit grossed up dividend yield tells you that it doesn't see these dividends being sustained.

Of course, the market is often wrong. And this really could be a bargain. I hold a small amount because on a 'through the cycle' basis there appears to be value. But it could be a bumpy ride.

The market doesn't like Adair's results -- shares are down 10% as I write this.

Let's see what's going on..

While total sales were up almost 13% for FY22, it's hard not to notice that the core Adairs segment (bed, bath, homewares products, which make up about 3/4 of total sales) saw a 4.8% drop in revenue and a substantial 42% drop in EBIT.

At the top line, you can blame the fact that Covid store closures meant there were 16% fewer trading days during the year, and an exceptional FY21 result. You can see below that the overall trend for Adairs store sales is quite respectable, averaging about 10%pa over the last 5 years (excluding Mocka and FoF). Or about 7%pa over the last 3 years.

Even with the store closers, like-for-like store sales were down only 3.3%. There was a 6% increase in the store footprint, and online sales are now 30% of the total and well up on FY20

BUT -- added supply chain and warehousing costs, higher staff costs and marketing effort all took a knife to margins. On a cash basis, added inventory levels also had a noticeable effect. Macro conditions are expected to remain difficult -- not a great environment for a discretionary retailer!

These kind of headaches are a big part of why I usually avoid retailers...sigh.

Then you have Mocka, which was very disappointing. While sales grew 6.5%, this was well below expectations following a weak second half, and there were also supply chain issues at play. More worryingly, there were "isolated product issues which led to adverse customer feedback and returns". This certainly helps explain a $1.2m inventory writedown. They've even put a new management team in place.

Another reminder that things can swing quickly in retail.

Focus on furniture, acquired in December 2021, was a standout. Although it represents just 13% of total sales, it was 22% of EBIT. It has the best margins of all segments and is expected to become a much more significant contributor to the group.

So the question here is whether or not FY22 results point to some difficult structural issues, or some nasty but temporary cyclical factors.

If the latter, the company looks pretty cheap.

They were able to sustain the final dividend, which puts Adairs on a yield of 7.8% fully franked. That's about 11% grossed up.

The PE is < 8.

And you have management guiding for growth -- albeit modest growth -- for the coming year. At the midpoint, management told the market to expect 14% revenue growth and 4.7% EBIT growth. The first seven weeks of the current FY are showing sales about 3.9% ahead of the same period last year.

They also reiterated expectations to hit $1b in total sales within 5 years (essentially double where they are now).

I think it's smart to assume lower margins going forward. Supply chain, FX and staffing costs could remain elevated for some time. Still, it's one of those situations where you really don't need growth to do well. In fact, so long as it can sustain an 18c per year dividend, investors will do ok.

The risk is that conditions deteriorate further. Lower than expected sales, combined with rising costs can be toxic. And it can be very difficult and expensive to turn things around. Worth emphasising that this is a company whose fortunes are closely aligned with the property market. People buying new homes and enjoying rising equity tend to splash out on homewares and furniture. Less so when things are going the other way..

I have a tiny holding (about 1.3% allocation), but am not tempted to increase this despite the apparent value. I'd just like to see evidence that margins can be stabilised and that sales growth can return to the core segment.

Results presentation here

Ouch.

Adairs gave the market an update on the expected H1 results for FY22, due on Feb 21.

The company is expecting to report $242m in sales for the 6 months through to the end of December, which includes a $12.5m contribution from the recently acquired Focus on Furniture (FoF). So on a like for like basis, that's a $230m result compared to $243m in the first half of FY21.

Underlying EBIT is expected to be between $32-33m, or around $30m excluding FoF. That's down from $60m in EBIT in the previous first half.

As can be seen above, like for like sales for the group were 2.7% higher, although that's due to a very strong performance from Mocka which masks a decline in Adairs stores.

The market's reaction has not been kind, which is perhaps understandable. But some context is needed.

The result was impacted by government mandated store closures which reduced the number of trading days by 31%. In NSW and VIC, the largest states, the number of trading days were essentially cut in half.

Management have tried to normalise for this, saying that Sales and EBIT would have been around $263m and $44m, respectively (excluding FoF).

The other major factor was increases in supply chain costs, something else that was beyond the company's control. That's acted to reduce gross margins (although these remain well above the levels of HY20.

What is within the company's control is promotional expenses, and these too increased and acted to reduce gross margins.

Online sales helped pick up some of the slack and are close to double where they were in FY20 and up 8.2% (excluding FoF) from the pcp. Workforce shortages, issues with the new DC and supply chain partner issues all had an impact.

As always, the key question when faced with disappointing results is "is this structural?"

I think the answer is no. These are all largely one-off factors, outside the company's control, and will resolve themselves in time.

It is, however, a good reminder of how harsh retail can be.

If we simply double the expected result for the half, Adairs is trading on a EV/EBIT ratio of about 7. That's not very demanding for a business that is experiencing pretty solid underlying growth.

Adairs provided a trading update at their AGM today, revealing a 8.5% drop in group sales for the first 16 weeks of the financial year.

On the surface, that's not great news. But as the share price reaction hints (up over 3% at present), there's more going on here.

Covid mandated lock downs meant that the business endured 47% fewer trading days over the period -- and that resulted in a 27% drop in physical store sales for the first 16 weeks of the year.

But on a like for like basis, Adairs stores improved sales 4.5%.

Encouragingly, in the first week of re-opening in NSW saw "strong like-for-like sales growth over the corresponding week in FY21". As management point out, this bodes well for the Victoria reopening which will be in time for the all important pre-christmas period.

Once again, the online channel saw the biggest growth with Adairs online and Mocka experiencing a 15% and 26%, respectively, increase in sales from FY21 (173% and 88% from FY20). Online sales are close to 40% of the group total now.

As with others, global logistic issues have resulted in increased costs which will impact gross margins (although these are still expected to remain above FY20 levels). Fortunately, managment took action earlier this year to lock in freight costs and hedge against USD movements.

The group has also brought forward inventory purchases to ensure they are well stocked for xmas. An ostensibly prudent move, although as we saw with Kogan this can have risks if sales dont materialise as expected.

There's a lot of added detail out today, and if interested i'd encourage you to read the AGM presentation and CEO address.

I'm usually not a fan of retail, but Adairs strike me as a very well run business whose leaders think long terms. The balance sheet is in great sheet (no debt) and they have doubled sales in the last 5 years. Potentially there's a long way to run too. 

Also important to note that they are not resellers, but rather higher margin brand owners with very loyal customers.

Moreover, it just seems cheap. Yes, the early days of the pandemic helped bring some sales forward, but even when you look at things on a forward basis, the PE is <12 and the company is offering 5.4% ff yield (that's 7.7% gross!).

I have a relatively small position on SM, although not in rl (mainly due to having no available cash at present). Like others, I'm mindful of what higher rates and excessive household debt may mean for discretionary household purchases, but i also suspect that that is somewhat in the price and that when viewed on a 'through the cycle' basis there's decent value here.

I'd also add that this isnt necessarily a long term buy and hold for me. I'd likely opportunistically sell if the market was to re-rate shares.