See the full story in the AFR this morning (12/07/2024): Shipping crises ‘spanner in works’ for inflation fight

Continuing threat of attacks on commercial ships by Yemen’s Houthi militants off the Horn of Africa has forced vessels to reroute around the southern tip of the continent, increasing journeys by two weeks, and adding to fuel costs for shipping companies while the logjam in Singapore is creating delays of more than a month for Australian consumers.

Anthony Scali, chief executive of Australian furniture retailer Nick Scali, said freight rates had increased dramatically while the company was also dealing with reduced shipping capacity for its imported goods.

“The big issue is the shipping lines just don’t honour contracts and hence the rates have more than doubled compared to your contract rates,” Mr Scali said. “Clearly this will cause importers and retailers to have to increase prices. Very inflationary.”

I picked this up from @Jimmy’s regular News Summary DJ Australian Equities Roundup (10/07/2024). I thought I’d move it here for future reference.

“Nick Scali keeps its bull at Macquarie, where analysts say Australian spending on home furniture remained resilient at the end of fiscal 2024 despite pressure on consumer spending. They tell clients in a note that the proportion of June consumer spending dedicated to furniture was largely in line with the year-earlier period. Foot traffic to Nick Scali's furniture stores in fiscal 2H also looks broadly in line with a year earlier, they say. Macquarie keeps an outperform rating and A$16.10 target price on the stock, which is up 0.7% at A$13.27. (stuart.condie@wsj.com)”

Tristan Harrison from The Motley Fool shared some upgraded broker price targets in his commentary on Nick Scali today. The average price target from the three brokers mentioned below comes in at $14.72. https://www.fool.com.au/2024/02/07/this-asx-all-ords-stock-is-surging-6-amid-multiple-broker-upgrades/

“According to reporting by The Australian, the ASX retail share has seen three brokers increase their ratings on the ASX All Ords stock.

Broker Jarden Securities raised its rating to overweight (which is positive) and increased the price target to $13.87. A price target is where the broker thinks the share price will be in 12 months.

Macquarie analysts have raised their price target on the company to $14.90, which is slightly higher than where the Nick Scali share price is currently trading.

Wilsons increased its rating to overweight on Nick Scali shares and bumped up the price target by 36% to $15.40.”

Thank you @DrPete for your kind words and your views on the future for Nick Scali.

After reading your straw I am starting to think that perhaps I have been too bullish with my valuation? Perhaps assuming a 5 year ROE of 40% might be a little too high?

Retail is definitely not out of the woods yet and I agree Nick Scali is in for a lower NPAT in FY24. I think in the short term putting a valuation on Nick Scali is a bit like gazing into a crystal ball. We’ve got to make some assumptions about the economy, interest rates, consumer sentiment, the housing cycle etc etc.

Post results, the brokers are starting to adjust their earnings forecasts and the 12 month price targets are starting to come through.

Taking a look at the 12 month price targets on Simply Wall Street the consensus for 7 analysts is $12.44. However, there is not much agreement here with the most bearish at $9.70 and the most bullish at $15.84. That puts my valuation of $16 in the bullish camp!

Source: Simply Wall Street (14/08/23)

The consensus earnings forecast for FY24 from six analysts is $69.3M, climbing up to $88M in FY26. Both significantly less than the $101M just announced for FY23.

Source: Simply Wall Street (14/08/23)

There is a large variance in earnings per share forecasts between analysts. Looking at forecasts from 5 analysts for FY25, the average is 98cps. However the highest is $1.18 per share and the lowest is 85cps.

This is how the variance looks graphically.

So this tells me there are probably too many variables for anyone to forecast Nick Scali’s earnings over the next few years with any degree of certainty.

I think the share price could vary wildly over the next 2 to 3 years depending on sentiment towards discretionary retail. I think there is likely to be trading opportunities for Nick Scali shares over the next few years. However, five years down the track I don’t think I want to be short on Nick Scali shares.

There has been some discussion on Strawman lately about when to Sell a stock. I think we currently have too much Nick Scali in our IRL portfolio (over 10%). For us, the higher the share price goes the higher the risk of holding it becomes. There is a risk of seeing potential profits evaporate! So if the stock approaches $15 to $16 per share I will most likely lighten off some shares and balance out our portfolio (unless there is some unforeseen good news about the economy and the housing cycle which Nick Scali will benefit from).

Similar to @DrPete, our cost base is $9.93 per share, so we could take some profits now. So you could say I am both a seller and a buyer of Nick Scali, a long term BULL and in the short term I’m CAUTIOUS. However, I can’t think of a better stock to get caught holding with a 5 to 10 year time horizon.

So we are holding too much Nick Scali in our portfolio at the moment and we have an opportunity to balance it out and take some profits now. But look at the chart!

I don’t claim to be an expert chartists, but I know enough to know this is not the time to lighten off. I will most likely hold until the MACD heads in a negative direction, then lighten off some of our holdings.

@mikebrisy, I wish I found selling a simple process. For me it is very hard, especially with a wonderful business like Nick Scali! :)

I haven’t heard the term ‘time horizon arbitrage’ coined before, but it makes perfect sense. Tim Carleton, Auscap Asset Management CIO talks about their approach to investing on ‘The Rules of Investing’ (Episode 170, 28th July, 2023).

Tim talks about looking past the 6 month horizon the market tends to focus on, and viewing businesses with a much longer time horizon.

In response to the final question, ‘Which stock would you own if the market closed today and didn’t open again for 5 years’, Tim’s choice was Nick Scali. He backed his conviction with the following reasons:

1. A founder run business
2. A long track record of high ROE, an average of c. 50%
3. Mostly ungeared, holding net cash 9 years out of 10
4. A very long runway of organic growth, with opportunity to double the store network over the next decade.
5. Recently acquired Plush where they have been improving the product, lowering costs to the consumer, while improving their own margins
6. Valuation is very attractive on a 5 year horizon. Tim said the biggest driver for furniture sales is housing turnover which is currently the lowest it has been in 20years

It’s an interesting podcast. He also talks about JBH, MIN, PLS, REH and REA, including some of their investing mistakes - both missed opportunities and acquired businesses going wrong.

He says they are long term investors, but talks about the reasons why they would sell a stock, with some real life examples.

Disc: Held IRL (8%), SM (15.6%)

FNArena's All-Year Round Australian Corporate Results Monitor - Macquarie reduced to Hold, Price Target $13.57

Disc: Held IRL (8.5%), SM (20%)

Here is a terrific summary of Why profits are up but share price is down at Nick Scali by Chris Bachelor for ‘Money Magazine’ published on 8 Feb 2023, copied below:

“Furniture importer and retailer Nick Scali (ASX:NCK) receives a Quality score of 99/100 based on Stockopedia's Quality ranking system. This means it is in the top 1% of all companies listed on the ASX based on a combination of quality metrics.

Nick Scali was established more than 50 years ago by the Scali family and listed in 2004. They raised $40 million in the IPO and have never raised any equity capital since.

During its listed life, earnings per share (EPS) has grown from 9c to $0.93, an annual growth rate of 14% over 18 years. The share price has increased from $1.00 to $10.33 today and they have paid out $4.275 in dividends. $10,000 invested into the IPO and held, would have yielded almost $140,000 in profits or an annual compounded return of 17.1% per annum.

This demonstrates how investors can accumulate large amounts of wealth by investing in high quality companies, and then remaining patient despite the gyrations caused by pandemics, property cycles, exchange rates and share market sentiment.

In the 2021 financial year Nick Scali, like many retailers, saw revenue grow at record rates as people were restricted regarding travel and going out, so they diverted their spending to sprucing up their homes. But unlike many other retailers, Nick Scali's revenue growth continued into 2022 and further growth is forecast for 2023 following a record first half.

However, a direct comparison is not entirely fair as Nick Scali's revenue growth was not all organic. It includes revenue from Plush-Think Sofas which they acquired in November 2021. Plush added another 45 furniture stores to the 62 under the Nick Scali brand. The acquisition was funded through debt and existing cash. The purchase price of $103 million represented an Earnings before interest tax, depreciation and amortisation (EBITDA) multiple of 3.8 which was not expensive.

Unlike many acquisitions this one is looking like it will add significant value to Nick Scali shareholders. They have already managed to strip out $20 million in running costs, benefits that go straight to the bottom line, as well as paying off $17 million in debt.

On Monday Nick Scali released their 2023 financial year half-year results. Revenue hit a record at $284 million for the half. Net profit was also up 70% to $61 million. Only two months of income from Plush were included in the previous period, versus the full six months this half year. The first half of last year also included extended periods of lockdowns in the eastern states.

Nevertheless, it is still a very strong result. Gross profit margins also rebounded to 62% helped by reductions in freight costs that had skyrocketed during the height of the pandemic. They have also seen big improvements in the gross margins at Plush as processes have become much more efficient.

Typically Nick Scali earns a little over 50% of its revenue in the first half, although the last few years have not been typical. If this held true, they could expect to earn about $560 million in 2023. Market analysts were forecasting full-year revenue of $537 million prior to the release of the results, so there is room for some upside to these expectations. Since the results announcement, some analysts have already started making small upgrades to their EPS forecasts.

Despite this seemingly strong result, the share price fell 13% on announcement day and a further 4% the following day. Which begs the question, why?

Admittedly the market as a whole also fell, but not nearly as much. It would appear that the declines were driven by a shift in sentiment regarding the outlook for the remainder of this financial year. Management expressed concern that rising interest rates may start to dampen demand, but so far they were not witnessing it.

Some of the commentary from the presentation of the results included that Nick Scali brand sales orders declined 3.0% but this is in comparison to the boom times of 2021. Further, written sales orders for January were 12.1% below January 2022. This includes prices reductions of 5% to 10% in January. Management expects price reductions across the industry. In part, this reflects the capacity to pass on some price reductions due to the benefits of the appreciating AUD, but the market probably also interpreted it as a sign that demand is softening. They also declined to give full-year guidance, citing uncertainty about the coming months.

There is no doubt that some pressure is building as interest rates rise and property prices fall, however, Nick Scali has ridden through many cycles in its history and has demonstrated it can come out the other side in good shape.

From a valuation perspective, some of the metrics are starting to look attractive following the price retraction. The forward PE ratio is only 9.2 which compares with a five-year average of about 13. The dividend yield is 7.6% fully franked.

The short-term risks for Nick Scali are heightened as the uncertainties around inflation, interest rates, the property market and the economy remain. However, the company is conservatively managed and has an outstanding track record of steady growth over the long term. The value proposition for the shares is much like that of Nick Scali's lounges. A quality product at a reasonable price.”

Disc: Held IRL (8%) and Accumulating. SM (20%). The writer of this article, Chis Batchelor, owns shares.

James Mickleboro shared another broker view in an article he wrote for The Motley Fool on Tuesday:

“Investors have been selling this furniture retailer’s shares since the release of its half year results. Macquarie has also responded to its results by downgrading its shares to a neutral rating with an $11.30 price target. The broker appears concerned by the headwinds the company is facing from higher interest rates and a cooling housing market.”

The price has dipped even lower today, down as low as $10.10. I’m loving it, and it will be better still if it falls to $8 to $9. Bring it on!

Is the Scali family reducing their 13.6% holding this week? Not that I’ve seen. They are too focused on opening new stores and improving the margins at Plush. Will there be a recession? Possibly. Will Nick Scali have a few tough years? Possibly. While I’m waiting for the economy to turn around hopefully the grossed up dividend will remain around 9%-10% (ie. including franking credits. This year should be closer to 11.4% grossed up yield). I’m happy with that for the foreseeable future, even if the price continues to fall. The recession won’t last forever (hopefully)!

Disc: Accumulating IRL. SM, reached my limit until it goes lower!

More broker views in the AFR today to add to those from@mikebrisy:

1. Nick Scali Cut to Neutral at Citi; price target $11.05
2. Nick Scali Cut to Accumulate at CLSA; price target $12

I think the market is getting the jitters with another 0.25% interest hike today and more needed according to Dr Philip Lowe at the RBA.

From the AFR this afternoon:

“The Reserve Bank of Australia on Tuesday pressed ahead with a ninth straight increase to the official interest rate, taking it to 3.35 per cent, and said more rises would be necessary to tame high inflation despite some families experiencing “a painful squeeze” on their household budgets.”

Disc: Held and Accumulating

Thanks for your trading updates @Invmum and @Seasoning. Were you as stunned as I was with the market reaction to the 1H23 result, share price down 13%! Fair enough there was no full year guidance but 13% down after beating guidance and the business continues to improve…Go figure??

Nick Scali increased 1H23 NPAT by a whopping 70% over 1H22, beating profit guidance two months ago of a 57% to 66% improvement.This huge boost was partly due to delayed deliveries in 2H22 and a full half year of Plush sales. Cost of doing business fell and Gross Margins improved by 2.5% from 59.5% to 62%. Plush acquisition cost saving synergies realised $20 million. The Plush business is also continuing to improve monthly as they upgrade stock and store layouts.

While this was once again a cracker half year result, written sales orders grew very slowly at 3.4% for the half and January written orders were down 12% PCP. However, this was better than Nick Scali was expecting being up 22.9% on pre-COVID levels.

I think Nick Scali will surprise to the upside for FY23. Analyst forecasts (S&P Global data on Simply Wall Street) average $93 million NPAT for FY23. Given Nick Scali has already landed $60.3 million of this in the first half, I think they’ll romp this in. The analysts also have Nick Scali’s FY24. earnings falling to c. $75 million, a mere $15 million more than 1H23 earnings.

I think the analysts and the market are underestimating Nick Scali…AGAIN! For me yesterday was a buying opportunity and I topped up IRL, and I’m now looking forward to the 3.7% fully franked dividend (for the half year!) just over a month away. Apparently investors and analysts were expecting a higher dividend announcement? The market is getting pretty hard to please IMO! For me, this incredible business is a screaming buy at 9x FY23 earnings, while it returns investors 40%+ on their equity in the business. I am happy to buy and hold this high ROE, well managed, founder owned business for a VERY, VERY long time…perhaps forever?

Disc: IRL 6% and adding. SM…I can’t add more than 20% of my portfolio apparently (otherwise I would have!).

I’ll take a closer look when I have more time. However, the bottom line is Nick Scali had a cracker first half with NPAT guidance up 57% to 66% on the PCP.

Trading Update

“Group written sales orders for the four months were $148 million, 55% above the prior year, with the strongest trading months being July and October. Nick Scali brand written orders were 21.7% above the first four months of the prior year and 35% above the pre Covid 19 FY20 year.

Final net profit after tax for the first half will depend on actual deliveries achieved before the end of December, including the risk of any future unknown external impacts affecting our distribution operations. Based on current delivery levels we expect net profit after tax for the first half of FY23 to be in the range of $56 to $59 million, 57% to 66% above the first half FY22 of $35.6 million.

Trading to date this year has been robust, though uncertainty on future near term levels of demand remain in the current economic environment. Therefore, we are unable to provide additional guidance for the full FY23 financial year.

Disc: Held IRL and SM

Bad Habits

Once a popular darling, Nick has developed some bad habits that no one wants:

1. Chases Retail
2. Very Discretionary in nature
3. Loves your home
4. Makes you wait for your lounge

Other wee issues

1. Interest rate
2. Inflation
3. Transport
4. Higher wages
5. COVID and Lockdowns (at home, China and Vietnam).

Nobody wants Nick

It’s not just Nick, it’s the entire discretionary retail sector.

But wait…This could be Nick’s BEST YEAR EVER!

”Given the scale of the outstanding sales order bank and deliveries in Q3 FY22, the Group entered the final quarter of FY22 in a strong position to deliver revenue and profit growth on the prior year.

This is despite lockdowns impacting sales orders during the first half of FY22 and temporary impacts to margin a result of unforeseen increases to freight costs following the Vietnam lockdown

The Group’s result will continue to benefit from the inclusion of Plush which will contribute positively to profit this financial year”

Heaps of orders…but there could be a wee problem with delivery!

“With current lockdowns in sourcing locations and ongoing delays in shipping as a result, the extent to which revenue and ultimately profit will be recognised this financial year cannot be accurately forecast at the current time (Macquarie Presentation, 4/05/22).

Nick gets the jump on FY23 too!

“Regardless of the level of deliveries that are completed by 30 June 2022, the Group expects to enter FY23 with an elevated order bank, and this will provide a solid platform for revenue delivery in Q1 FY23”

Tough times ahead? Nick has a good model

Note: NOT a Nick Scali lounge

My wife and I ordered a Nick Scali leather lounge at the end of January 2020, just before the full impact of COVID. We shopped around at a number of other retailers before eventually settling on the lounge at Nick Scali. Why? We liked the modern styling and quality of Nick Scali lounges. We fell in love with the lounge!

I tried to bargain, with no success (it’s not part of Nick Scali’s model). I also questioned the minimum upfront 30% deposit, but that wasn’t negotiable either. We put down the deposit of $1870 expecting an 8-12 week delivery. Of course with COVID the delivery got blown out to 4 June 2020, 4 months later. Before delivery we paid in full for the lounge (Total $6170). We also paid extra for a care package (conditioning treatment) and additional warranty (5years).

I asked the delivery driver (contractors) how business was going with COVID. He said they were run off their feet and couldn’t keep up with deliveries. I bought shares in Nick the following day. They were cheap at the time (around $5) because the market was worried about the impact of COVID. How did that turn out? Best year ever!

So why is this a good model? When Nick takes the order they bank 30% of the retail price and before the customer receives their lounge they are paid in full, plus any add on extras. The lounge is not handled by Nick Scali, it is delivered directly to the customer. Factory, Ship, Warf, Transport, and Customer. Nick Scali’s job is to arrange the logistics and collect the profit. The delivery is done by contractors.

The only stock they own is the display stock which they sell at a slight discount when they discontinue a line.

There are 3 models for retail:

1. Just in case - warehousing stock ready for sale (done to avoid delays in delivery, risky, costly, double handling, risk of outdated stock, cash tied up in inventory)
2. Just in time - careful inventory management, minimal stock held, less cash tied up in inventory. JB Hi-Fi does this well.
3. Order/Deliver after payment (This is the Nick Scali model- Less risk, less handling, lowest cost, no old stock when they discontinue a style)

‘The time to buy retail stocks is when no one wants them’

I think it was last year when retailers were just starting to come off the boil I heard Jun Bei Liu say something like, ‘the time to buy retail stocks is when no one wants them.’ If there was ever a time when no one wants retail stocks it would have to be now.

I think Nick Scali will have a decent FY22. Next year could be a bit tougher, but I think this is a quality business that should ‘pay you to play’ while you wait for them economy to improve.

Disc: Held and accumulating

In today's AFR story “Smashed Small Caps that can turn into portfolio treasures” Paul Biddle, portfolio manager for Celeste Funds Management said “The time to put money to work is when everyone is running for the fire exits.”

He also said “At times like these, few people want to own small-cap industrials. That’s when they get oversold”.

“In a weakening market, our preference is small caps that can reliably deliver a 4-6 per cent yield, before franking,” says Biddle. “That’s not a bad outcome if the sharemarket is flat this year. We liken an attractive yield to being ‘paid to play’ while we wait for market conditions to improve – and for our industrial small-cap portfolio stocks to re-rate higher.”

I whole heartedly agree with Paul Biddle’s comments above, particularly this one, “being ‘paid to play’ while we wait for market conditions to improve”. Thats how I’ve been reshaping our SMSF portfolio this year. As a retiree, CASH FLOW in your SMSF is just as important as it is for a company you might hold in your portfolio. It’s ALL about CASH FLOW for retirees when you are in pension phase. You are required to withdraw a minimum amount each year (reduced to 2% for us this year) so if you are mostly invested (like we are) you must have dividends, or you’ll need to sell some shares! Not a good outcome in a bear market. Now back to the AFR story.

Coincidently, I also go along with some of Paul Biddle’s stock picks:

Biddle said “Housing-related stocks have challenges as rising interest rates reduce demand for new furniture and other discretionary items. Nick Scali has fallen 44 per cent from its 52-week high.”

“Biddle likes Nick Scali’s expected yield of about 7 per cent, the strength of its forward order book and its recent results.”

”We don’t doubt that some people will be less inclined to buy a new couch as interest rates rise,” says Biddle. “But Nick Scali delivered yet another strong quarterly update and has a lot of cash locked in through its forward-order book. They have used excess cash through COVID-19 to acquire Plush (a rival sofa retailer), which will significantly grow Nick Scali’s medium-term earnings.”

Not all fund managers agree with Paul Biddle about housing related stocks though:

“Richard Ivers, portfolio manager of the Prime Value Emerging Opportunities Fund, is wary of housing-related stocks. “We’re avoiding any small caps that rely on the housing cycle or consumer discretionary spending, unless it offers compelling value. With interest rates just starting to rise, there’s too much earnings uncertainty.”

I guess this is where the risk lies with businesses like Nick Scali especially if the Aussie economy goes into a recession. Personally I think our economy will be much stronger than most countries over coming years, with the backing of mining and agriculture.

Other small caps Biddle likes are Smart Group (SIQ) and HT&T. I like SmartGroup, but personally I wouldn’t include HT&T because of it’s historical low ROE of 3.5%. I prefer businesses with ROE greater than 15%. Nick Scali has a consistent historical ROE of 50% over several years. Smart Group has an historical ROE of 20% to 30%.

Read the full AFR story for small cap picks from other fund managers.

Disc: Shares held in Nick Scali and Smart Group.

Last week (10 & 11 May) the Nick Scali Chairman, John Weir Ingram, bought 25,000 shares on-market averaging $9.42 per share coming to a grand total of $231,000. That’s $31,000 more than his annual board remuneration of $200K. ASX Announcement

If the Chairman thought it was a good time to buy shares in the company last week, today looks even better, down 4.5% to $8.80 during the day.

Disc: Adding today IRL

After gleaning the Macquarie Conference Investor Presentation it looks like Nick Scali is on track for another record year (FY22). The only thing that might prevent full sales being realised in this financial year is the current lockdowns in sourcing locations and ongoing delays in shipping.

Macquarie Conference Investor Presentation

Trading Update:

• H2 FY22, to 30 April Written sales orders for the four months to April, including Plush, totalled $182.2m, up 36.5% on FY21
• Total written sales orders for Nick Scali for the four months from January to April 2022 were in line with the same period last year. This is despite a decline of 6% in January 2022, due to the escalation of the Omicron outbreak that significantly reduced store traffic at the start of the year. This improvement has been underpinned by the performance of the Australian stores.
• The Q3 trading momentum continued through April, with written sales orders for the Group up 41.4% on April 2021
• Nick Scali stores recorded sales orders growth of 7.5% in April, with comparable store sales order growth of 4.4%. Consequently, the outstanding order bank at the end of April remains elevated, up almost 90% on the previous year

Historical Performance:

FY22 Financial Year:

• Given the scale of the outstanding sales order bank and deliveries in Q3 FY22, the Group entered the final quarter of FY22 in a strong position to deliver revenue and profit growth on the prior year. This is despite lockdowns impacting sales orders during the first half of FY22 and temporary impacts to margin a result of unforeseen increases to freight costs following the Vietnam lockdown

• The Group’s result will continue to benefit from the inclusion of Plush which will contribute positively to profit this financial year

• However, with current lockdowns in sourcing locations and ongoing delays in shipping as a result, the extent to which revenue and ultimately profit will be recognised this financial year cannot be accurately forecast at the current time.

• Regardless of the level of deliveries that are completed by 30 June 2022, the Group expects to enter FY23 with an elevated order bank, and this will provide a solid platform for revenue delivery in Q1 FY23

Disc: Accumulating