Unfortunately I bought into Dusk a few years ago when candles were popular during the pandemic. Now I think the well-being community are steering clear of artificial fragrances and sweet smelling fragrance are now on the nose! My wife warned me about this and I should have listened!

I managed to offload some of our holding before the latest spiral downwards, at a significant loss. Today, Dusk is trading at 78cps, cum a 2.3cps fully franked dividend (goes ex dividend this Monday, 11th March).

I feel like just biting the bullet and selling it so I can wipe the red off my screen. However, the business is debt free and holds 50cps in cash. The businesses is now trading at just over its equity value. All it needs to do now is run at a profit and return 10% return on equity to make future returns look reasonable. The big question here is will Dusk continue to run at a profit?

Providing they don’t squander their cash away by rolling out loss making stores, and they can turn a reasonable profit, the business looks too cheap to sell at today’s price. I might live to regret this, and my wife will continue to remind me of it too!

Worst Investment Ever! :(

In an ASX announcement this morning Dusk were quick to advise “it has not been approached by any prospective buyer or advisor in relation to a privatisation or takeover. Dusk said Ord Minnett are acting on their own initiative and do not have a mandate or arrangement with dusk in relation to this matter. We have not seen or contributed to the content of any document purported to have been prepared by Ord Minnett.”

The ASX announcement was in response to an AFR Street Talk story published yesterday (and copied below). I haven’t come across this approach before (ie. an instruction booklet on how to takeover over a company) but it probably happens all the time? I’m curious to see if anything develops from here.

Project Dawn: A flyer, a banker and a candlestick maker

“Dusk’s bombed-out share price is attracting attention.

Street Talk understands stockbroker Ord Minnett is shopping around the ASX-listed candle and diffuser retailer, putting an investment opportunity flyer in front of potential acquirers.

The 43-page deck, dubbed “Project Dawn”, outlines the business’ financial performance, its abysmal trading performance since December 2021, the make-up of its register and how best to mount a takeover.

Ords recommends a scheme of arrangement via a full cash offer, which it calls a “friendly approach”, because of the strong representation of the board and management on the register.

“Early engagement with board and management who together own around 9.6 per cent of Rusk will be critical,” Ords argues.

“Board and management have a modest but important combined stake and may be influential on top institutional shareholders’ views. We believe the remaining major institutional shareholders may be open to an initial approach, and suggest early engagement to ensure alignment of interests with key shareholders.”

Ords’ friendly approach recipe aptly starts with a “fireside chat” with Dusk chairman John Joyce, followed by a formal written and verbal approach. The aim is to secure an agreed solution and receive a board recommendation.

Its alternative approach is securing a prebid stake from Dusk shareholders, including early engagement with its largest intuitional shareholder, Regal, which has a near 5 per cent stake, which it says would be considered “quasi-aggressive”. Then, it would put forward a scheme of arrangement or an off-market takeover.

It’s not surprising to see a document like this circulating. This is what bankers such as Ords’ Steve Boggiano and Sam Robinson do for a crust – try to get people to buy something and make a fat fee off the back of it. Whether it results in a transaction is another question altogether.

Still, Ords corporate finance team knows its target better than most, having advised Dusk on its $124 million initial public offering in October 2020. The company listed at $2 per share and has been trending down since December 2021, last trading at 94¢. Ords points out this means a reasonable cash offer would “likely gain board and shareholder attention”.

Dusk has 145 stores across Australia and New Zealand, selling candles, perfumes, oils and new lines such as personal fragrance ranges. Sales are under pressure given a broader slowdown in consumption as interest rates rise, but the company finished last financial year with $19.7 million EBITDA and an $11.6 million net profit.

To ward off any interlopers, Ords recommends getting on the front foot, doing “early engagement with the target and key shareholders”.

ENDS

Disc: Held IRL and SM

This story came from ‘Street Talk’ in the AFR on Friday morning:

Barrenjoey trades 4pc of Dusk Group; offshore fund sells

“Barrenjoey’s equities desk crossed 2.46 million shares in Dusk Ltd, representing 4 per cent of the company shortly after market open on Friday.

Sources said the seller was an overseas institutional investor, while the buyers were spread across a couple of local funds including Regal. The trade was done at 82.5¢ a share and totalled just $2 million, but its timing is interesting.

It comes after an obscure Thai hedge fund, BNG Special Situations, built a 3.5 per cent stake and began agitating for a buyback as reported by The Australian Financial Review on Monday. BNG did not buy any shares in Friday morning’s trade.

Dusk, which makes candles and diffusers, is down 52.6 per cent over the past 12 months. BNG has argued Dusk has strong cash flow, high margins and a loyal customer base but is being undervalued by the market.

The fund’s assistant managing director, Vikram Sachatheva, has said Dusk shares should be worth $3 to $4 and the company should buy back shares at anything below the $1.50 levels. It is currently trading at 92¢ a share and listed in 2020 at $2 a share.”

Disc: Held IRL and SM

We hold Dusk and now have the quandary of what to do with it. Is Dusk a Buy, Hold or Sell?

One thing that is now clear is that Dusk floated at a very opportune time on 2nd November 2020. COVID 19 meant that lots of people were stuck at home and at the same time goverments were propping up the economy with cash injections and interest rates were low. Things that made your home more comfortable, appealing and entertaining were very popular with consumers.

Shopping centres reduced rents to retain tenants and the goverment compensated retailers to keep people employed during lost trading days. Online sales increased because customers couldn’t go to the shopping centres. Interest rates were low and people felt rich as equities and property prices started to soar when it became apparent COVID 19 was not going to end the world or the economy.

Discretionary homemaker retail did exceptionally well and Dusk’s fortunes peaked in FY21 with NPAT of $21.9 million and ROE at 75%.

ASX data

In FY22 things came of the boil for homemaking discretionary retailers as people got tired of being couped up at home and things started to normalise. Despite this COVID 19 shutdowns we’re sporadic. Dusk’s NPAT dropped back to $18.5 million and ROE dropped to 53.6%.

FY23 is a very different year to the previous two years. COVID 19 has dropped in severity. People are living normal lives, albeit more people are now working from home.

Inflation is high (c. 7%) and interest rates are the highest we’ve seen since the 1990s.

https://themortgagereports.com/61853/30-year-mortgage-rates-chart

People are starting to feel poorer and are spending less. Foot traffic in shopping centres is lower than previous years.

The costs of doing business (CODB) for retailers is rising. Wages are higher. The award wage for the retail industry increased 5.2% last year. Shopping centres are charging more fo rent. Power costs are increasing, but shipping costs have normalised after COVID.

Dusk is feeling the squeeze on margins from both ends. Sales have fallen more per store than the results indicate. Dusk has increased the number of stores from 132 to 145 (10% more stores) yet sales have declined by 2%. 2HFY23 will see an EBIT loss of about $3million for the half (1H23 EBIT $19.1 - FY23 EBIT $16).

Gross margins have remained similar at 67% however CODB has been increasing (Could be close to 50% of sales now) Dusk now has 10% more stores to run and 10% more rent to pay (About 25% of CDOB). Wages will increase by 15% due to the 5.2% award increase and 10% more stores (about 50% of CODB). There are 10% more stores to stock at inflated prices and more stores to fit out in the new Glow 2 format. The Glow 2 format looks smart, stylish…and very expensive!

So what does this mean for Dusk going forward. I can’t see sales magically increasing as interest rates rise and people feel poorer. I can’t see rent reducing, especially if dusk rolls out more stores, I can’t see wages going down…EVER, and inflation is proving to be stubborn.

All we can conclude from this is that FY23 net profit margins of approx 8% (NPAT $11/ Sales $135), down from 11.5% in FY22, might be as good as it gets for a few years to come. It might even go slightly lower if sales go down and costs continue to go up).

If we work on a ‘new normal’ of 8% net profit margin, that puts Dusk on a ‘new normal’ ROE of 26% (NPAT 18cps / Book Value 70cps).

Valuation

When it comes to making a Buy, Hold or Sell decision I like to use valuation as my guide.

Because ROE has fallen from 75% (FY21) to 54% (FY22) to 26% (forecast FY23) you can’t use historic PE as a valuation tool. Historical PE is now a nonsense for Dusk. In fact PE is never a great valuation tool because it has no relation to business performance.

For the sake of valuation I’m going a little more cautious and using a ‘new normal’ ROE of 25%. Dusk has a strong balance sheet with net cash close to $30 million and current book value of 70 cps. Dusk historically pays out 70% of earnings as dividends, reinvesting the other 30%. It should pay out about 12cps fully franked dividends this year unless the board decides to do something radical (18 x 70%), 8cps has already been paid. You could expect 4 cps to be declared for 2H2023. That’s a total 11% fully franked at the current price of $1.10 per share.

To value the business I’m going to use a required return (RR) of 15% allowing a higher margin of safety for the uncertainty.

Using McNivens StockVal formula, my updated ‘new normal’ valuation (including franking credits as part of future earnings) is $1.75, close to my previous valuation of $1.80.

What will I do with Dusk? I will hold what we’ve got and watch the share price momentum looking for a possible entry point to add more. It can be a very painful experience trying to catch a falling knife so I don’t see any rush today.

Disc: IRL (3.6%) It used to be much higher! :(

On the rare occasion I visit the main shopping centre in Toowoomba I try to fit in a quick visit to each of the retailers we own shares in. Sometimes I’ll have a chat to the manager about how business is going.

Last week I went to visit Dusk and found it all boarded up!

I thought, this doesn’t look good!

I sent an email off to Dusk and was relieved to find out the store was undergoing an upgrade to the new Glow 2.0 format, and will be reopening this week.

In their 1H23 presentation Dusk said they would be focusing on converting the remaining 24 legacy stores to the new Glow 2 format. It was good to see this is underway. Dusk has probably picked a good time to do the upgrade with foot traffic in the centre much lighter than usual. I’ll be keen to see how the new format goes on my next visit.

Disc: Held IRL (5%)

Dusk released its 1H23 results and presentation today.

1H FY23 Overview

• Total sales of $86.1m, +7.6% vs pcp1 (1H FY22: $80.0m); +47.0% vs 1H FY20

• Total Like for like sales (LFL)2 was -10.4%

- Stores -6.9%

- Online -37.8%

• Gross margin of $57.7m, +6.1% vs pcp

• Gross margin rate of 67.0% compared to 68.0% in pcp

• Pro forma EBIT4 of $19.1m, -10.2% vs pcp; +98% vs 1H FY20

• Net cash of $32.9m at period end and no debt (1H FY22: $33.3m)

• 141 stores (including online) at period end, an increase of 9 new stores

• Inventory of $17.6m at period end (1H FY22: $19.6m)

• dusk Rewards active members of 722,000 (1H FY22: 718,000)

• Interim fully franked dividend of 8 cents per share

Expectations

Overall the results were better than I was expecting, and are ahead of what analysts were forecasting for FY23 (S&P Global data on Simply Wall Street). Prior to the results announcement the average analyst earnings forecast for FY23 was $13.5 million. Dusk has already achieved NPAT of $13.3 million in the first half (down 9.5% on pcp). Before you get too excited you need to know Dusk earnings are heavily skewed to the first half. Last year 80% of the earnings came from the first half. If this repeats we could expect FY23 earnings to be c. $16.6 million compared to $18.5 million last year.

1H23 Profit & Loss Summary

Sales were up 7.6% on pcp, however you need to consider there were 9 new stores (141 in total). Like-for-like sales were down 10.4% on pcp.

Gross Margins slightly lower

Gross margins were down slightly (98 bps) to 67% driven by increased promotional activity and AUD deterioration versus USD. On the conference call CEO, Peter King said 2H23 gross margins should stabilise at 67%.

Cost of doing Business Higher

The biggest impact on earnings was increased cost of doing business (CODB), increasing 16.3% to $36.7 million. This is due to higher employment costs (13 additional stores open and a 5.2% award wage increase), higher store rent (more stores plus CPI).

Strong Balance Sheet

Solid cash conversion of earnings.Net Cash $32.9 million. Net assets up 11.5% to $43.7 million.

Outlook

Dusk didn’t provide full year guidance. Total sales for the first 7 weeks are 3% down on pcp, but 29.3% higher than preCOVID levels. 6 new stores will be opened in 2H.

Valuation

A number of assumptions are required for the valuation. I will assume earnings in H223 will make up 20% of FY23, a similar weighting to FY22. I’ll work on FY23 earnings of c. $16.6 million. I expect gross margins and CODB to stabilise at current levels and future ROE to pull back to current levels of c. 27%.

Using McNiven’s StockVal formula and assuming normalised ROE of 27% going forward, dividend payout ratio of 70% (historical), franking of 100% and a required annual return of 14%, I get a valuation of $1.80 (close to the current share price). If you were happy with a 12% required annual return you could pay up to $2.20 per share.

Given the current pressure on household budgets and the risks for discretionary retailers going forward I’m going with a valuation to $1.80. Assuming FY23 earnings of $16.6 million or 26.8 cps, that’s a very undemanding forward PE ratio of 6.7x.

Disc: Held IRL (5%), SM (3%)

Late this afternoon Regal Funds Management lodged an initial notice of substantial holdings in Dusk. In two tranches on the 8th September and the 29th November, Regal Funds bought 4,470,932 shares averaging $1.89 per share, total $8,468,395. According to the notice Regal Funds held 3,872,447 or 6.22% of Dusk shares on 29 November. The first tranche averaged $2.05 per share, and the second tranche averaged $1.80 per share.

I couldn’t find anything in the media about the transactions. However, my guess is that Regal Funds has bought almost all the shares held by Capital Investments, each tranche at a significant discount to market value (c. 12% discount to the previous days of trading). On the 6th September Dusk was trading at $2.38 per share and within a week the share price had fallen to Regal Funds buy price of $2.05, and it kept falling due to the momentum. On the 24th November Dusk was trading at $2.14 per share, and once again within a week it had fallen as low as Regal Funds buy price of $1.80.

This might also explain the mysterious volatility in the Dusk share price as Regal Funds has taken advantage of the arbitrage on 589,486 of the shares it has just bought, but aren’t included in the 6.22% share holding on the notice on the 29th November.

I’m hoping the selling will ease up now the price is close to Regal’s average cost price of $1.89 per share. In fact, now Regal is the largest shareholder it will be in their interests to see the majority of their holdings appreciate in value. Perhaps we will see something in the media over the next few days.

Disc: I have shared my thoughts on what I suspect might be happening with Dusk trading lately. Much of this is highly speculative in nature and not based on fact. Held IRL and SM.

Yesterday (30/11/22) independent non-executive director Tracey Mellor added 8900 shares on-market at $2.14, totalling $19,038, Announcement.

I bought more Dusk shares myself yesterday on a mystery 8% fall in the share price. This might be a result of Dusk’s largest shareholder, Catalyst Investments (holds 7%), dumping more shares on the market. Last time Tracey Mellor bought shares it was followed by a sell down by Catalyst Investments.

The share price dropped to $1.81 at one stage yesterday. I didn’t see the the shares trading as high as $2.14 during the day which makes the director buying price a bit of an anomaly.

I have added more shares today. I think the value and dividend Dusk offers is too good to be ignored. I’ve also worked out that Dusk have about 34 cps sitting in cash alone.

At least for now they are cashed up, highly profitable and run a high margin, high ROE business that pays a dividend c. 10% FF (14% grossed up with franking credits).

Even if the share price stays flat for 5 years, Dusk should return about 14% per year in dividends, in which time the shares should pay for themselves (The Rule of 72). I’d be happy with that for an outcome.

Risks - The looming risk for Dusk is the possibility of a recession, in which case fragrances might get a bit on the nose!

Disc: Accumulating IRL and SM.

Dusk has traded reasonably well for the first 19 weeks of FY23, and I think should be ahead of analyst expectations for FY23.

Total sales are up 23.9% pcp on FY22 and down 4.5% on record FY21. Although, Dusk CEO Peter King, said “Like-for-like sales are not considered a useful measure in the first half of FY23 given the extent of store closures in the prior corresponding period.” - Chairman and CEO Addresses

While it would be easy to extrapolate the strong sales result from the first 19 weeks of FY23 forward, Peter King warns “it is prudent to reinforce the importance of December trade to dusk’s full year results.”

So we need to be cautious about what might happen from here. However, Dusk is well ahead of FY22 sales and only 4.5% behind Dusk’s record FY21 year. Anything is possible from here.

If Dusk has a good Christmas trading period, FY23 sales should be at least somewhere between FY21 ($148.6 million) and FY22 ($138.4 million). Currently analysts are forecasting FY23 sales to be c. $134.9 million, or 2.5% lower than last year (4 analysts, S&P Global data).

Dusk has opened five new stores in Australia in time for Christmas and have refurbished a further four legacy stores to the Glow 2.0 fit out. Dusk has also entered the New Zealand market and early indications are positive.

Even though it’s still very early into FY23, I’m feeling positive about the prospects for Dusk this year and it is still possible for Dusk to surprise the market to the upside.

AGM Presentation

Disc: Held IRL and SM.

Dusk looks to be facing a challenging 1H 2022 going on today’s (11/11/21) trading update.

The first half revenue, which includes Christmas trading, is historically higher than 2H and critical to the full year results.

The trading update is for the first 19 weeks of 1H 2022 ending 7 November 2021:

Dusk said sales have been adversely impacted in the period by the government mandated stores closures in NSW, Victoria and ACT. This has reduced the number of store trading days by approximately 33% over this period.

Given total sales are down nearly 23% compared to the same time last year, this makes the remaining 6 weeks of Christmas trading critical for the FY22 results.

It is concerning that like-for-like sales (Like for like sales calculation excludes stores closed for refurbishment or COVID-19 related closures.) to date are a down 8.5%.

As a shareholder, I will be anxious to see the 1H 22 results in February 2022 and hoping Dusk can pull a rabbit out of the hat!

Quietly I am anticipating Dusk to have a flat FY22 result at best, with a return to growth in FY23.

I remain bullish on Dusk for the long term and think Dusk shares at around $3 are a great buy.