Consumers grappling with higher inflation are likely to pull back on discretionary spending during 2023. Having acquired Plush, Nick Scali is now even more exposed to a potential sales slowdown.
NCK’s performance throughout the pandemic was typical of many retailers that catered to home improvement spending. The company’s FY22 sales outcome was affected by COVID disruption to shipments, and this flowed through to a revenue decline at Nick Scali (excl Plush) of -5.6%. Offsetting this, the order bank for Nick Scali was up 20.4% indicating revenue had simply slipped into FY23f.
A lower gross margin at Plush at the time of acquisition (52.4%) improved 280bp during the year (8 months of ownership). NCK gross margin was impacted by rising freight costs. The group gross margin of 61.0% was down from 63.5% in the prior year.
Rising employment costs added 280bp to the cost of doing business, relative to sales. EBIT margin for FY22 was therefore down from 34.4% in FY21 to 26.6% in FY22. This included Plush, of course.
With Plush now fully included and representing about 40% of group sales (46 stores), FY23f will look nominally much bigger. Consensus forecasts have incorporated this effect, so we look to FY24f as a guide to earnings momentum. On this basis, consensus FY24f EPS will decline by 11.1% suggesting slower sales, higher costs or a combination of both will impact on earnings.
The balance sheet remains comfortable with only a modest amount of net debt following the Plush acquisition ($102.5 million, November 2021). Inventory levels will need to be carefully balanced between orders and deliveries to avoid any need for discounting.
Investment view
NCK clearly benefitted from the COVID-19 period as consumers stayed home and used savings to upgrade their homes. At the time of the FY21 result in which the company reported comparable store sales growth of 34% with group total sales increasing 42% yoy, consumers were prevented from travelling and other normal spending behaviours such as eating out.
With inflation now uppermost in consumers’ minds, discretionary spending will fall but this does vary by category. Furniture sales tend to lag interest rate rises by at least six months, but we expect comparable store sales numbers to turn negative in 1H of CY23.
The ability of the company to mitigate rising costs is the other key factor impinging on EPS growth and we anticipate further pressure in this regard.
Risks To Investment View
Discretionary consumer spending could be more affected by rising interest rates than we anticipate. NCK could be holding more inventory than it can sell, requiring discounting and promotion to clear stock, impacting gross margin.
Recommendation
We have retained our Hold recommendation.
