Adairs released half year results this morning. These were largely pre-reported in their trading update released in Jan. However some of my thoughts are below:-

• Adairs online & Mocka continued to grow sales despite cycling some huge growth numbers in the previous year. This is promising and solidifies the trend of the groups online sales to continue becoming a larger part of the total sales. If focus on furniture wasnt acquired, Adairs online & Mocka would have most likely become more the 50% of total sales within the next couple of years.
• Gross margins compressing is not great, however its still elevated from pre-covid levels. So it may be a result of last years gross margin levels were never sustainable and this is now a more realistic level to base numbers from going forward. And if Adairs can start passing through some of the supply chain and material costs to customers, we could see a return to higher gross margins, however this would have to be a gradual process.
• I like the Focus on Furniture acquisition, it allows for great cross-selling opportunity of the Adairs products. Focus is also very early on in their growth story with plenty of store rollout, expansion opportunities available, expecially outside of VIC.
• On a sum of the parts valuation i still think this is very cheap stock. See my straw #hidden in plain sight where i explain this in more detail.

You can see results here

Does Adairs have hidden gems hiding in plain sight inside its business trading at crazy low multiples?

How much would you for an online retail company with sales CAGR of over 30%? What about over 50%? As a reference point see below online retail business which trade on the ASX. 

Temple and webster - 5 year sales CAGR 53% - PER 123x

Redbubble – 5 year sales CAGR 38% - PER 37x

Kogan – 5 year sales CAGR 30% - PER 61x (historical average)

City Chic - 5 year sales CAGR 25% - PER 66x

These businesses trade at super high multiples due to high growth of their top lines and growing markets.

Based off the above I can comfortably assume that an online retailer with a top line 5-year CAGR of 30% could be assumed as very cheap if it traded at a PER of 20x. Same could be said for an online retailer with a 5-year CAGR of 50% if it traded at a PER of 30x.

If we think about Adairs as 3 x separate businesses and assess the value of each.

Adairs online – 5-year sales CAGR 52%

Adairs online contributes 28.9% of the total sales (excl Mocka). Total Adairs underlying NPAT (excluding Mocka) was $66.4m. That implies the NPAT contributed by Adairs online is minimum $19.2m. Which would make the EPS for Adairs online 11.4c based off 169.08m shares on issue. Therefore, if I apply a 30x PER to 11.4c the valuation for this business standalone would be $3.42.

Mocka – 5-year CAGR 30%

Mocka underlying NPAT was $9m. Which would make the EPS 5.3c based off 169.08m shares on issue. Therefore, if I apply a 20x PER to 5.3c the valuation for this business standalone would be $1.06.

Adairs store based – 5-year sales CAGR 7%

Adairs online contributes 71.1% of the total sales (excl Mocka). Total Adairs underlying NPAT (excluding Mocka) was $66.4m. That implies the NPAT contributed by Adairs stores is $47.2m. Which would make the EPS for Adairs stores 28c based off 169.08m shares on issue. Therefore, if I apply a 7.5x PER to 28c the valuation for this business standalone would be $2.10.

Adairs Group total – Adairs online $3.42 + Mocka $1.06 + Adairs Stores $2.10 = $6.58

Adairs has a 64.8% Gross margin (much higher than TPW, KGN, CCX & RBL) with a 6% dividend yield.

Is this a case of a couple of hidden gems masked as a bricks and mortar retail business? Or is another case of where a REA is inside Newscorp and destined to be discounted forever?

Bull case short thesis for Adairs - The company earnings has rocketed up in the last 12 months. With the current "housing frenzy" being experienced around the country at the moment, its my theory that this will provide a stabilising tailwind in the medium term. More first home buyers enter the market & new houses being built, renovations from the governments grants, Adairs should be well positioned to capture continued sales uptick as these buyers/renovators splurge on new homewares and linens. 

Adairs is a well established, trusted retailer. And covid has accelerated the trend of increasing percentage of sales to online. This should keep margins elevated and hopefully trending upwards as this percentage grows. 

Even prior to Covid the company had strong consistent year on year growth:-
Revenues 5 years prior to Covid.

• 2015 - $210.88m
• 2016 - $253.18m
• 2017 - $264.96m
• 2018 - $314.77m
• 2019 - $344.43m

Averaging approx. 13% per year. 

The main risk in my eyes is if sales decline post covid period. But with a currently undemanding PE i think this is priced in. From my perspective covid has only accelerated the company's trajectory - at least in the medium term as outlined above. This in conjuction with the margin expansion which i see as permanent due to online sale percentages remaining elevated and increasing YOY into the future. 

And to mitigate risk a little more, they pay a relatively healthy dividend.