Overview Comment:

Overall, a negative result but about what I expected (actually slightly better). I am expecting profitability to be around $5-6m for this FY so 1H NPAT of $8.1m should allow that exception to remain (2H is always weaker). Without the strong cash backing I would definitely be out due to risk of failure. The current valuation on an EV/E with my assumption of $5-6m FY24 profit is approximately 4-8x (depending on low/high cash figures between halves) so not a demanding multiple and probably the only thing keeping me from selling. I am well aware I could be stuck in a value trap here so needs constant monitoring. At this point continued holding requires that current conditions are nearing the bottom of the cycle and as consumer confidence returns Dusk's operating leverage will return.

General notes:

• Dividend of 2.5c
• NPAT $8.1m, about where I expected it to be, with H2 I would expect NPAT to be negative due to the usual seasonality. EPS 12.9c.
• Store network up to 151 stores. 2H will be see 4 store openings with 5 store closures of underperforming stores.
• Not expanding NZ offering until conditions improve.
• Improving rate of total sales decline compared to PCP for FY23 as FY24 progresses, first 7 weeks -15.6%, first 20 weeks -11.3%, 1H -9.7% and first 7 weeks of 2H -7.8% with December 8%. However, consumer was starting to weaken at this point last year.
• Sales conversion rate remains stable.
• Multiple notes about continued focus on maintaining costs.
• CFO leaving not long after new CEO started. Don't know if good or bad? Gives a potential for a fresh start but also is there internal issues with new CEO? Not much information on changes CEO intends to make.
• Amazon store opened in the half.
• No outlook provided; however, this is normal for Dusk.

Positives:

• Maintained gross margin at 64.5%.
• Net cash $31.1m.
• Invenvtory managed well with figure flat at $17.6m even though number of stores up by 10.
• CEO appears to want to attract new younger customers.

Negatives:

• Sales $77.8m down 9.7% on total or 15.8% LFL. LFL very troubling.
• CODB up 5.9%. Due to wage increase of 6.25%.
• Online sales still struggling at 5.3% of sales or $4.1m. Website redesign coming.
• Membership numbers down 703k from 735k at FY23 year-end (1HFY23 end was 722k). Price increase to $15 hasn't worked so going back to $10.
• Membership ATV has decreased from $64 in 1HFY22 to $57 1HFY24. Membership makes up 56% of sales.

Has the thesis been broken?

• No, but remains on a very close watch with a sell if there is any sign that Dusk won't improve performance when the consumer confidence returns. Still has a strong cash backing so can't see financial stress as such in the next year or so.

What are you expecting and what do you need to see over the next reporting season or generally into the future?

• That conditions don't continue to deteriorate. Expecting that we are nearing the bottom of the cycle over the next year or so.
• Will the CEO start to make visible changes to improve results?
• Continued focus on controlling costs and maintaining gross margins.
• Continue using statutory figures rather than proforma numbers.
• Company "on watch".
• FY24 NPAT of $5-6m and sales ending the FY down around 5-8% compared to FY23. 

• First 20 weeks sales of $38.8m down 11.3% on PCP. Only positive was online sales which were up 8% compared to PCP.
• "Slight improvement since October". With "encouraging Christmas early response".
• 6 new stores have opened in the current FY and 3 pop-up stores have been opened for Christmas. Pop up stores allow Dusk to test centres that do not have a store or expand an existing footprint. Net 3 new stores expected in 2H.
• Will be launching Amazon marketplace store in December.
• Strategy to expand into regional centres is working well according to new MD. Recently opened Mildura store recorded the highest opening day of trade in the companies history.
• New sales incentives for staff over the Christmas period.
• 500 casuals have been onboarded for the Christmas period.
• Will continue with "collaborations" such as Streets Ice Cream collaboration which was very successful. The trailed perfume range was successful. 

General notes:

• Revenue = $137.6m (-0.6%).
• Statutory EBIT = $18.0m
• Dividend of 3c per share. Not cut but not as big as I expected. I think it is about right in terms of size given results.
• Introduction of click and collect and redesigned website due 2HFY24.
• 6 stores expected to be opened in 1HFY24.
• New CEO to start in October.
• Still 24 stores to be updated to Glow 2.0 format which has a proven ROI.
• Trial stores in NZ are in line with expectations. However, rollout will only occur once economic outlook improves.
• Compared other years of first 7/8 weeks. Even the non-covid FY20 doesn't provide a decent indicator to the final sales. Ie not consistent and this isnt a major trading period for Dusk. 

Positives:

• NPAT $11.6m. Higher than my expectations of $7-10m. Though 1st half wasn't to bad. Economic conditions only hit hard in the second half.
• ROE = 31.6% (with 43.5% of equity being cash with no debt).
• Inventory levels dropped slightly even with the addition of 13 stores. Dusk has not mismanaged its inventory like other retails over the past year or so.
• Management have already implemented a $2m CODB reduction program. Majority of this was in relation to staff wages so will have an ongoing impact.
• Net cash $16m.
• Membership slightly down to 735k from 755k at the end of FY23. However, I was expecting a much bigger drop off from the sign ups during FY21 when Dusk was booming. This is actually an improvement from 1HFY23 and signups and renewals up 9.8% compared to previous year.
• 4% increase in sales conversion when customers enter the store.
• Looking to expand perfume range prior to Christmas after fast sell out of trial range.

Negatives:

• First 7 weeks FY24 total sales down 15.6% compared to FY23. For contrast this is still 29.2% above FY20 (pre-covid) sales. Generally outlook still looks poor due to macroeconomic factors. It was noted in the call that this number is cycling the "Streets" product launch which was extremely popular and sold out quickly.
• ATV decreased 5.7% to $51 showing the consumer is a lot more cost coconscious
• Gross profit margin down 160bps to 64.1%.
• CODB up 11%. To $67.8m from $61.1m. This flows through the financial statements. Mainly impacted by wage increases and some stood down periods in the previous year. 6.6% increase on a like for like basis if staff wont stood down.
• Online sales down 35.2% and below management expectations. Idon'tt see this as core to the business.
• LFL store sales down 11.1%. With foot traffic down 10.2%. 

Has the thesis been broken?

• No, but on watch, mainly because the core of the business model hasn't change. Key metrics such as ROE still very high (espically considering a large portion of the equity is cash). This is a cyclical company, while I never expected profitability to be maintained at the highs of COVID, I did underestimate the drop off. The company will need to be on watch.
• While the current outlook isn't positive, I can see Dusk making its way through the current environment given the strong net cash position of the balance sheet. I would be much more worried if it was net debt. There is still growth potential long term. There is a clear operating leverage effect on this business which at the moment is a weakness. For a profitable return from here, I will need to see the operating leverage effect work again. Running some numbers based on FY23 results $5m NPAT in FY24 will be achievable with 5% drop in revenue and a 5% increase in CODB. This is my minimum expectation.

What are you expecting and what do you need to see over the next reporting season or generally into the future?

• Is this the new normal or just the current economic conditions are hurting Dusk?
• I think statutory numbers can be used for comparison moving forward given post covid impacts and listing costs are no longer relevant. Proforma numbers were actually worse than statutory this FY so management isn't being funny with these numbers.
• Is foot traffic a potential indictor of sales? Matched pretty closely?
• Profitability in the first half needs to be in a range that enables a $5-10m FY24 NPAT.
• Company on watch. Will need to get out with further deterioration. 

Expectations:

• Gross margin maintained around the normal level for the business.
• Expecting NPAT $7-10mil
• How are LFL sales going for start of this FY? Are revenues down more than 2HFY23? Hoping they match the 2HFY23 percentage change at worst.
• I won't be surprised if the dividend been cut to help protect the cash buffer. I expect a dividend of around 5c or better otherwise I don't think the market will be happy. 
• Have membership numbers been maintained now that they are rolling of COVID windfalls? Expecting a fall, maybe up to 10%? Membership numbers were at 720k at 1HFY23.

Questions to Answer:

• Determine the reason for the negative EBIT margin impacts. Trading update looked like loss in profit attributable to below the gross margin line. Can the EBIT margin changes be reversed easily?
• Any direction on where the new CEO is going to take the business?
• How is the NZ rollout going?
• What is the cash balance and what are the boards plans reference the previously high cash balance?
• What is the outlook going forward? More pain to come or is this the worst of it?

Overview Comment:

The trading update released today was overwhelmingly negative. The attribution towards slower consumer spending was a risk I was aware of but wasn't expecting the EBIT margin decrease as much as stated. The question is how long will this last for? Is it just a temporary blip caused by the interest rate hikes or is weak consumer confidence going to be a theme of the next 1-2 years. This question is key as to whether to continue to hold Dusk as if this is more than just a temporary decrease in EBIT/NPAT margins then more bad news can be expected. 

General notes:

• Sales slightly below FY22.
• Management blames strains on household budget/interest rate hikes.
• I am estimating a NPAT of $10m for FY23 as a result of the announcement.

Positives:

• Gross margins have been maintained.
• Still high sales conversion rates according to management. 

Negatives:

• Pro forma EBIT for FY23 forecast = $16-17 mil. Implying a $2-3mil loss for 2H, 2H is normally weaker but hasn't been a negative result in recent times.
• Market didn't like the news. Down 28c or 19% to $1.28.
• Mother's Day sales were weak. This is normally a major trading period for Dusk.
• The downgrade in profitability is below the gross margin part of the P&L. What has increased costs so much?
• Was expecting revenues to grow at least on a LFL basis. Given flat revenues, and an increase of 14 stores. LFL basis is definitely down.
• EBIT margin has moved from 19.1% in FY22 to 12% for FY23f.
• Is there a potential of a dividend cut? Given the loss in 2H. Heaps of cash but does management want to preserve this given the negative outlook?

Has the thesis been broken?

• Maybe, conviction has been lowered significantly. Dusk is still cheap, but can it get cheaper? Is it a value trap? Something is causing reduced EBIT and NPAT margins which is of concern (especially given gross margin is reported to be maintained). Normally more unwelcome news comes after the first downgrade so is it better to sell (potentially at the bottom) or is this as bad as it gets? My valuation has basically halved in less than a year. Not a good sign for the position. Company definitely #OnWatch and #Nobuy, potentially looking to sell all or part of the holding. Having a think over the next week or two. 

Valuation:

See valuation straw for updated valuation.

What are you expecting and what do you need to see over the next reporting season or generally into the future?

• Must meet expectations set out in the trading update.
• Are weaker results going to be a one off or continue?
• Maintain membership numbers.
• Understand the impact new CEO will have.
• Determine the reason for the negative EBIT margin impacts.

Dusk has announced Vlad Yakubson as the next CEO and MD of Dusk. Vlad is currently the general manager of yd. Previously, he has worked for Mad Mex and Glue Store. Vlad will begin working for Dusk by no later than the end of October.

Peter King has run the business very well so I am disappointed to see him go, however, pleased there is going to be a well-planned transition. From a quick search on the net, Vlad appears to be a good candidate. All the brands he has worked for previously have been growing retail businesses with a narrow segment focus much like Dusk.

Looking to add to position after a bounce of recent bottom. Quick review of key points to remember before moving forward purchase.

Positives:

•  Note the following values: EV = $67mil and MC = $97m, ($30m cash). Note FY22 E = $18m. This gives the following implied valuations:
• If E = $10m then EV/E = 6.7x or P/E = 9.7x
• If E = $13m then EV/E = 5.2x or P/E = 7.5x
• If E = $15m then EV/E = 4.5x or P/E = 6.5x
• Given above the market is pricing in profitability to decline strongly. 
• No balance sheet issues. Strongly cash backed. 
• No change to the core of the business:
• Gross margin around 67%.
• Only run profitable shops on a local store basis. 
• Expanding into NZ, continued Aus store rollout and 24 stores still to remodel providing growth.
• Paid membership program to engage with repeat customers. 
• First 7 weeks of 2H matched FY22 approximately. 

Negatives:

•  CEO resigning. Will the changes the new CEO makes be positive or negative? The current CEO has done a very good job and created a very sustainably profitable retail business. 
•  Macro outlook not great for consumer discretionary. Market is not going to price this highly anytime soon. 

Overall, I see a good opportunity to buy at the current price. The fundamentals of the business haven't changed. Bounced off the recent lows. This has often happened with Dusk, share price craters well below $2, then bounces back to around the $2 mark. Looking at the implied valuation it is very cheap, the numbers above imply the company goes backwards from FY22 and doesnt make a profit in 2nd half, you still can buy for a PE of well under 10x and much lower when you consider the EV. As a result, adding to my position, don't see much potential downside on a risk adjusted basis.

Overview Comment:

The consumer pull back in discretionary spending and inflation effects are evident in the Dusk results with flat sales and increases in CODB. The business still has maintained a very strong balance sheet backed by cash to weather any issues that may occur in the current environment. Every store operating on a profitable basis and a continued high ROE are good indicators that Dusk is continuing to be well run by management, however, the CEO transition will be important to watch to ensure this continues into the longer term. Over the shorter term I expect subdued results, however, over the longer term I see no signs of a poor return on investment especially considering the dividend income and ability to continue to expand the business through store openings.

General notes:

• Financials:
• Dividend = 8c (fully franked)
• Sales = $86.1m (+7.6% vs pcp)
• Total LFL sales = -10.4%
• Gross margin rate 67.0%
• EBIT = $19.1m
• NPAT = $13.3m
• EPS = 21.4c
• Net cash = $32.9m
• Inventory = $17.6m down from $19.6m in PCP
• NTA per share = 66.53c
• 9 new stores opened in 1H finishing with a total of 141. 6 new stores expected in 2HFY23.
• 722k members vs 718k at end of pcp. Membership appears to be flatlining. Always expected at some point. For reference:
• 1 in 28 (3.5%) of adult Australian's have a Dusk membership ($10 fee every two years).
• 1 in 5.4 (18.5%) of adult Australia's have an active Myer one membership which is free.
• Still 24 stores to update to latest format which has a very good ROI historically.
• No guidance given.

Positives:

• Inventory down on same period even with a higher store count. Dusk has managed inventory well.
• Sales conversion was 70% vs 57% in pcp.
• Foot traffic outside of stores was -29% vs pcp. Therefore, Dusk potentially did relatively well.
• NZ in line with expectations.
• All stores profitable.
• Balance sheet is still very strong, net cash approx $33m, with a closing price of $1.84 a share this net cash figure represents around 28% of market capitalisation ($116m).

Negatives:

• Sales down for first 7 weeks of 2HFY23 by 3%. Store based sales down 1%, however, note this would be on a higher number of stores, therefore, LFL down further.

• CODB up 8% vs pcp on an adjusted basis for 1HFY22 store closures. This is driven by "new store, increased wages and inflation".
• Online business is struggling. Only $4.8m in sales. Is this even worth maintaining? Presentation notes company has identified multiple improvements that need to be made to the website and platform.
• Gross margin down slightly due to "increased promotional intensity and AUD vs USD".
• ATV down 5.7% "driven by a more cost-conscious customer".

Has the thesis been broken?

• No, valuation does need updating to cover the shorter-term impacts of inflation and lower than forecast profits. The fact management states that every store is profitable shows the underlying format of Dusk works and is profitable.
• Previously I had been worried about the profit to cash conversion. This half has greater "cash profits" than P&L profits therefore this has reversed and therefore not an issue going forward.

Valuation:

Updating based on shorter-term expectations being weaker.

• PE target = 12
• Profit = $16 mil
• Cash = $33 mil
• Market value = (12 x 16) + 33 = $261 mil
• Valuation per share = $3.61

What are you expecting and what do you need to see over the next reporting season or generally into the future?

• CEO transition period will require watching. Do results continue? Are the changes the new CEO makes positive or negative?
• Watching effect of sales and lower NPAT on longer term thesis.
• Membership numbers to remain around 720k. Not expecting any significant drop off or improvement.

Peter King, Dusk's CEO presented at the ASX Small and Mid-Cap Conference this morning. Below are my notes from the presentation:

• Dusk doesn't employ any buyers. All stock is developed in-house with the help of long-term suppliers. Good product development example - latest product range sold out early.
• Only a small change in gross margin in FY22 compared to bumper FY21. CEO very pleased with this. 
• Very slight inventory build is explained by increase in store numbers and opening of new stores.
• As ultrasonic diffusers are bought or gifted, they are creating a reoccurring revenue stream through the consumables used, which are sold at higher margin than other products. 
• Membership program is very important to the business model. The pay-to-play model shows intent of customers to make repurchases. "I pay $10, get $6 off this time then need to come back again to make back my membership fee". Then customer keeps coming back for 10% off. Dusk and customers are both winners.
• Online penetration overseas of products that Dusk sells is much lower than other retail segments. Customers like to come into the store due to the tactile nature of the product and the experience.
• Expansion:
• No store target in Australia.
• First store in NZ opening in Auckland on 15th September 2022.
• NZ market looks very positive for Dusk. CEO expects it to be more profitable and the product is cheaper compared to the local competition.
• International expansion beyond NZ would likely be the UK. Not the right time though. CEO was there in June 2022.
• Eroma deal didn't go ahead because management didnt think it was the right fit after completing due diligence. CEO said M&A will not occur if it is not earnings accretive. Still looking for M&A opportunities. 
• No more shares in escrow and main holder has been able to sell shares for a while now. 
• No store is unprofitable. Store fitouts normally subsidised by landlords. Payoff for new stores normally within the year and opened at the right time of year to ensure this occurs. 
• Peter King has been CEO since 2014, the company has grown significantly during this time. Adding to thesis that he is key personnel. You could tell he knows the detail of the business very well. 

Below are some general comments based on additional information provided by the results release compared to the recent trading update (see previous straw for those details) that was released on 20th July.

Positives:

• Membership numbers continue to rise to 755k. Sign-ups and renewals were 358k, down from 413k in FY21 but still up on FY20 figure of 278k.Cycling this was still an increase from 688k same time last year (membership period is two years).
• 67% of sales are non-candle sales. Proving Dusk isn't just a candle shop but a fragrances and homewares store.
• Store network up to 132 stores (net +10 for FY). Entry into NZ in 1HFY23. International expansion is a great growth opportunity. 5 new stores in Australia by Christmas.
• 'Repeat customer visits driven by high margin scented consumables.'
• COVID lockdowns had a material impact on sales results for FY22, therefore for Dusk to make my thesis NPAT of $20m should be much easier this coming FY. Potential to do much better.
• Still 27 stores to update to latest store format which has a proven ROI.
• No inventory blow out like has been occurring with other retailers.
• Final dividend of 10c, fully franked. At a share price of $2.41 and a total dividend of 20c for the FY, this gives a yield of 8.3% or gross yield of 11.9%. It seems like the board is paying out 100% of cash earnings.
• Sales for start of FY23 look positive. DSK actually provided figures for comparison to FY20 which is a non-COVID period and sales were up 53.5%. Other retailers have only been given this figure for FY22 which is hard to provide any context to. Sales were up 33.2% on FY22 where COVID lockdowns were in place but slightly down on FY21 which was the COVID bumper year. Positive overall, for the FY23 result if the non-lockdown period results can be maintained.
• Management is executing well. If you look at the graphs in @Rick's straw the track record shows a very good CAGR result over the last 5 years for key metrics.
• I like that Dusk releases key figures early (on 20th July for FY end of 3rd July). Though would be good if they released the official results a bit earlier than the 2-month rule so it doesn't look like they are holding off to the market.

Negatives:

• Cost of doing business up 6.6% while revenues were slightly down.
• Online not getting traction, however, again part of the thesis that this is the case.
• Didn't provide guidance due to macro-environment. Not a big deal, guidance for a retailer really is just a guessing game in my opinion.
• Terminated Eroma acquisition cost $1.06m.

What I would like to see/expecting to see over the next financial year:

• Would like to see the FY22 total membership number maintained. The membership is a big driver of sales (approx. 62% of all sales) and members spend more per transaction.
• Need to watch cash compared to income statement, this appears to be just differences in timing but something to check over a few FYs.
• Expecting an increase in sales over FY23 thanks to cycling period of lockdowns in FY22 and as a result, improved profitability over FY22.

Overall Comment:

Dusk released its FY22 trading update with unaudited figures. Overall, positive for the thesis as the results were all as I expected with no surprises. Nice to see the overseas expansion starting in the next half, I see this as the future growth driver of the business if they can get it right.

General Notes:

• Total sales of $138.3 mil down 6.9% from FY21. LFL sales down 10.5% compared to FY21. This is flat compared to the LFL from 1HFY22. Sales being down on the COVID boom was always expected. LFL accounts for COVID related store closures, 1HFY22 saw a loss of approximately 24% of store trading days.
• Net cash $21.3 mil. Inventory at $15.4m. Similar to this time last year.
• Management is happy with inventory position and made Christmas orders with no expectation of delays.

Positives:

• Proforma EBIT (excludes IPO costs and benefits of JobKeeper and rental concessions etc) expected in the range of $26.3-26.8 mil. Therefore, NPAT will likely be around $18.5 mil. Within my expected range of $17-20 mil.
• 10 new stores were opened in FY22 in Australia. 5 stores expected to be opened in Australia before Christmas.
• NZ expansion to begin with 3 stores opening in September/October.

Negatives:

• Online traction is still weak. Especially given the membership program. Only up 2.9% compared to FY21. However, thesis is based on the fact that Dusk sells products that consumers want to be there to physically touch and smell before buying so not a deal breaker.

Has the thesis been broken?

• No, results are all as expected. Sales seem to be stabilising after the COVID boom around where I expected. Overseas expansion is about to begin which was an expected avenue for growth, new stores are continuing to be rolled out as well.

What are you expecting and what do you need to see over the next reporting season or generally into the future?

• Expecting the same results as this year or slightly better. On the positive side the negative impacts of store closures in 1HFY22 should not be felt in 1HFY23, however, lower consumer confidence and higher costs will be a negative factor on next FY results.
• Continued store and overseas expansion.
• Maintain or grow the number of members. This may be hard given the 2-year cycling that might start to occur from the COVID boom.

General Notes

• Key financials:
• Sales down 12% to $80m. LFL sales down 10%. LFL excludes the effect of closed stores.
• Proforma gross margin of 68%, slightly up from 67.7%.
• Proforma EBIT of $21.3m. Down from 1HFY21 ($28m) but up from 1HFY20 ($9.6m). While proforma EBIT is down this was expected as part of the thesis. FY21 was a COVID boosted year, I never expected this to be beaten. Still significant improvement on FY20.
• NPAT = $14.7
• Net cash $33.3m.
• Fully franked dividend of 10c declared.
• Dusk is preparing to commence operations in New Zealand. Expected in Q2FY23.
• Acquisition of Eroma announced within the reporting period. Transaction consisting of $15 in cash payment and a placement of $13m of Dusk shares (4.496m shares @ $2.89). Transaction to be completed in 2HFY22. New $10m debt facility will be used for part of the cash component.
• First 8 weeks trading update sales:
• Total sales down 11.8% (matching 1HFY22 approximately)
• Sales LFL down 14.8%.
• Online sales up 19.4%.
• Foot traffic down sharply.
• There were distribution disruptions during the 1H but inventory for 2H reported as "healthy".
• 6 new stores opened during the period with 4 new stores expected by Mother's day.
• CEO bought shares on market at around a price of $2.50 this replaces most of the shares sold in August at around $3.05. CEO holds 2.26m shares and chairman 2.275m shares so both significantly invested in the company.

Positives

• Average transaction value increased 5.8% to $57. Strategy to higher prices is showing through in ATV. ATV of members was $64.
• Membership program continued to grow to 718k members. This program produces 62% of total sales up from 59% in 1HFY21. HFY22 had more sign ups and renewals of membership that 1HFY20, very positive.
• Trading update noted freight costs are elevated but not as high as 1H. Good sign for margins in 2H.
• 66% of sales were non-candle sales. Dusk isn't just a candle store.
• Fully franked dividend of 10c. Based on $2.70 share price and annualised this give a yield of 7.4% or grossed up yield of 10.6%.

Negatives

• Total sales and LFL sales down but expected.
• Online sales only up 2.8% (cycling 120% from FY20) to $7.7m. Not impressive given the amount of time NSW/VIC were in lockdown during the period. However, thesis is based on the idea that customers actually want to go to the store to buy Dusk's products. Fragrances are physical so require the physical presence of the customer.
• Store days lost were around 24%.
• Shares from IPO come out of escrow on 3rd March. Potential for share price weakness.

Has the thesis been broken?

• No, thesis is playing out as predicted. While results won't hitting it out of the park, my thesis is based on $20m NPAT annually. This was a reduction from the COVID boosted FY21. Membership numbers continue to increase which is very positive and a key driver of growth. The Eroma purchase is very logical and will be earnings accretive. Based on my expectation of NPAT, DSK has an ROE of 50%, very high thanks to very good capital management by the board. High convection maintained.

Valuation

•  Valuation remains with factors target PE = 12 and NPAT =$20m as yearly price target.

What are you expecting and what do you need to see over the next reporting season or generally into the future?

• Expecting profit for FY22 to come in around $20m as per thesis. 1H NPAT of $15 makes this likely. 2H is always lower due to Christmas sales boost.
• Cycling of membership program will start to show through in next half for the next two years. Maintaining membership will be important but will not be surprised if membership drops somewhat (but not dramatically) given members that signed up during COVID peak might not renew or have moved on. 1HFY22 had more sign ups and renewals of membership that 1HFY20 which is a particularly good sign.
• Per share earnings/results will be important to compare over the next few years due to the Eroma transaction which will issue 4.496m shares (6.7% of shares after offer).

General Notes / Neutral outcomes

• Update is for 26 week to 26/12/21.
• Total loss of trading days for the period was 24%.
• Expected EBIT $21.0-21.5 mil. Down from $28.3 mil 1H FY21 but up from $9.6 in 1H FY20. Given the hard half for retail this result was expected. COVID related uptick in sales wasn’t expected to accelerate again, slight pull back unsurprising.

Positives

• Management strategy of early ordering seems to have worked well given the supply chain issues currently affecting most retailers.
• Gross margin maintained at 68% during a tough period.
• Net cash of $33 mil.
• Eroma expected to be EPS positive from integration on 28 Feb 2022.

Negatives

• LFL sales down 10.1% this means the Christmas period was slightly down on the previous year as the LFL sales from 19 weeks to 7/11/21 were down 8.5%. Though total sales only down 12% for the half (was at -22.9% at previous update).
• Online only grew slightly (4.3%) over a period where I would have expected online to do well.

Has the thesis been broken?

• No, but maybe a need to watch the sales into the future. Need to ensure sales maintained this current level (or only small decrease from COVID peak). Valuation based on NPAT of $20 mil profits during normal operations. This appears to be around the figure that will be hit for the year.

What are you expecting and what do you need to see over the next reporting season or more generally into the future?

• LFL sales in 2H not down more than 10-15%.
• Expecting NPAT 2H of $3-5 mil. Year range $17-20 mil.

Dusk has announced the purchase of 100% of Eroma shares. Eroma is a supplier of candle making, soap and home fragrance supplies (see attached presentation image). They are only a supplies business with over 900 fragrance formulations, therefore, Eroma works in a related but different segment of the market. The deal will transact on 31 January.

The enterprise value acquisition is $28 million, which equates to an EV/FY21 EBIT of around 5x. This is funded though $13m in DSK shares, $10m in new term debt with CBA and $7m from existing cash. Management believes the acquisition should be highly earnings accretive from year one adding to pro forma EPS by over 20% (before any synergies). No change to DSK dividend payout policy is expected as a result of the acquisition. The shares issued will be held in escrow with 25% released after each HY financial result, with first released after FY22 result.

Summary of benefits listed by management:

• Increases TAM.
• Increases the scale of DSK online operations.
• New specialised segment for DSK.
• Geographic and range expansion through the used of shared facilities, knowledge and relationships.
• Increased buying power of overlapping input costs.
• Eroma owns over 900 fragrances, this gives DSK a large range of new formulations to use in the creation of their own products.
• Improved distribution through the use of shared facilities.
• Highly EPS accretive.
• Some Australian based manufacturing capability.
• Potential for synergies.

Personal Notes on Acquisition:

Overall, this is a very good acquisition for DSK shareholders especially due to the instant EPS accretion from year one. The potential for synergies is clear and all numbers presented are on a pre-synergy basis. The fragrance IP will be valuable for DSK given they create their own fragrances.

The purchase price seems like a great deal for both parties. I like the structure of the deal especially the use of shares given the slightly lower relative EV/EBIT purchase price. Only question is why they didn't use cash given the previously high amount of cash on the balance sheet. My thoughts here are that DSK has had to pay for its Christmas stock and/or trying to keep cash for dividends. The term debt adds only a small amount of leverage to the business. 

Dusk has launched an online brand called Mihi Home. Looking at the products and prices this is definitely a premium brand compared to the current Dusk offering. Hopefully an even higher margin brand for Dusk. Will be interesting to hear commentary from management on the aspirations for the new brand.

Facebook and Instagram the pages only have a few hundred followers at the moment so a bit of work to do to increase brand awareness (as expected given it is a newly launched brand).

General Notes

• Hit guidance. Could say lower end but on or around is pretty much a rounding error.
• Increase in membership is a very positive sign. This is a number to watch closely. This is a good indicator into the future about the potential future sales and if the COVID profit boost is sustainable. Membership makes up for 60% of total sales.
• 67% of sales were non-candle. Showing DSK isn't just a candle shop. However, most growth was in candles and diffusers so still core business.
• Potential for a subscription model? To jump on the bandwagon, "Fragrances as a service" or "Scents as a service" as the financial analysts will call it... Given the high membership sales to total sales ratio I can see this being quite an interesting opportunity.
• Website was updated recently. Gave it a quick test run. Seems very user friendly. I find many UI's annoying, Dusk's website UI seems quite good. All items seem well organised into categories and the right number of items in each category, you are not overloaded or underloaded with items.
• Still 35 stores (out of 122) to update to latest fit out which has a proven high ROI.
• Final dividend of 10c. 25c total dividend YTD. Fully franked. This equates to a 35.7c grossed up dividend. Giving a yield of 7.6% or gross yield of 10.8% based on opening price.
• Proforma numbers appear fair to use given IPO costs, Jobkeeper repayments and rental concessions. No clear manipulation of the numbers for gain by management in the use of this metric.
• General figures:
  • NTA = 45.65c per share.
  • Total sales = $148.6 mil
  • Statutory NPAT = $21.9 mil
  • Proforma NPAT = $26.8 mil
  • Total costs without IPO = Approximately $60 mil vs $52 mil for FY20. Approximately +15%.
  • Diluted EPS = 34.6c (statutory).
  • Net cash = $24.1 mil
  • Operating cash flow = $35 mil

Positives

• Great growth numbers:
  • Total sales +47.4%
  • LFL sales + 32.7% (excludes stores closed for refurbishment or COVID-19 related closures.
  • Online sales + 27.0%
• LFL sales increase 2/3rds due to increasing transaction numbers the other 1/3rd an increase in transaction value.
• Membership up +31% to 688k.
• General figures look very good (proforma figures used):
  • ROE: 98%
  • P/E: 7.6 (based on $3.28 a share)
  • EV/EBIT: 4.75
  • Gross profit: 68.1% (vs 65.1% FY20)

Negatives

• Weak outlook for 1HFY2022 until opening up of NSW and VIC.
• FY YTD LFL sales down 11% is very concerning. Is this due to the strong reopening effect of PCP in FY21? Good online figures at least. 1H earnings are mostly generated in Nov/Dec so if closed stores have reopened by then the sales in that period will show the prevailing conditions.
• Concerning Q4 FY21. While high growth numbers were not expected given the significant growth in PCP, I would have liked to see this a bit flatter at least. Thesis based on there being some retraction from COVID reopening sales so not overly concerned considering the FY22 YTD figure is less of a decrease at 11% and impacted by Sydney and Melbourne lockdowns. However, YTD total sales are down 28%, which equates to a $4.4 mil impact on sales over 7 weeks. For those interested see LFL sales performance chart in presentation.
• Some margin pressures in the second half. Likely to continue IMO. Pressures were input costs, FX hedging and rising freight costs.
• Dividend did not equal 1H. Board quotes current COVID related issues. Seems prudent, however, also an indicator of potential struggles at the moment.
• Movement into NZ market has been delayed due to COVID.

Has the thesis been broken?

• No. Thesis was a P/E play. P/E and EV/EBIT still low but normalising over my holding period.
• Weaker Q4 and current FY YTD sales are concerning but expected. Thesis was based on ongoing NPAT of $20 mil when COVID growth subsides. Proforma profit is well above this figure (by more than 30%) so there is a margin of safety. Target P/E of 15, high target PE because of the quality of management and the multiple potential growth opportunities though online, Australian store number increases (+30% more than current) and international expansion. This PE target may be a bit high but I am using the conservative NPAT figure. Either way I get a EV of around $300 mil.
• I feel happy to hold given the decent dividend yield, low multiples (PE + EV/EBIT) and great ROE figures the company produces. I think these factors provide decent protection from a significant share price decrease. The uncertainty over the next few months about sales will likely be reflected in weak share price growth over that period.
• What to watch to for:
  • Maintaining and increasing membership will be critical. Will members renew?
  • Sales for Q2 will be very important and a good indicator to the ongoing business post COVID.
  • FY20 to FY21 shows the impact of operating leverage. Revenues can not reduce significantly from FY21 and profitability be maintained.

Valuation

• Maintaining PE target of 15 with NPAT $20 mil plus cash. Market cap = $324 mil. Valuation per share =  5.20.