Fantastic: An Opportunity In Furniture

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-Initiates coverage as a Buy
-Flexible competitive business model
-Growth based on upturn in housing

By Eva Brocklehurst

There's opportunity in furniture. Furniture retailer Fantastic Holdings ((FAN)) has moved into the sights of Goldman Sachs with a Buy rating and 12-month share price target of $3.60. The company operates a vertically integrated model including retailing, manufacturing and importing, and Goldman is of the belief this provides flexibility and competitive advantage. The broker, in initiating coverage of the stock, says the FY13 estimated price/earnings ratio (12.3 times) and yield (4.8%) look attractive within the small industrials segment (12.8 times and 4.4%). Goldman expects improved earnings will lead to a re-rating of the stock over the next couple of years.

In FY13, Goldman expects earnings growth to be driven by the turnaround of underperforming operations, cost reduction and modest sales growth in a subdued consumer spending environment. However, FY14-15 is when store expansion and a recovery in the housing market should lead to even greater growth. The GS economics team forecasts a rise in Australian new residential construction from 131,000 in 2012 to 145,000 in 2013 and 170,000 in 2014. Recovery in new house building is the key factor and with it Goldman expects a recovery in consumer demand for furniture to lead to higher sales growth in FY14-15 for Fantastic.

Fantastic was purchased out of receivership by Julian Tertini, Peter Brennan and Peter Draper in 1996 and listed on ASX in 1999. Its signature store brand, Fantastic Furniture, operates 71 company-owned and two franchised stores and accounts for 55% of the store network. Plush operates 32 stores across Australia, offering high quality stylish sofas while Original Mattress Factory (OMF), started in 2006, has grown to 15 stores throughout NSW. Dare Gallery operates 10 company-owned and one franchised store, focused on providing customers with furnishings. Fantastic purchased Dare from administrators in 2008. Fantastic also owns two Le Cornu stores. These are large format stores offering a broad range of home furnishings and home entertainment systems located in Adelaide and Darwin.

Goldman expects Fantastic to increase its store numbers to around 200 longer term (currently 133), mainly from its top three brands, and sees the underperforming Le Cornu, Dare and Fantastic WA turning around. The broker expects Le Cornu to move to a small profit in FY13 from a loss of $3.4m in FY12. Goldman notes the furniture market is relatively fragmented with the top five retailers holding a 33% share, the largest being Harvey Norman ((HVN)) with 12%. Potential consolidation in the furniture sector exists as small independents are impacted by strong competition and volatile trading conditions. Furthermore, in Goldman's view, mid-market retailers may suffer loss of market share given the expansion of the value-for-money retailers such as Fantastic Furniture. Where Fantastic is also currently giving others a run for their money is with Plush. Goldman said the brand's ability to sell a large range of sofas at competitive prices is taking the competition up to Harvey Norman and Nick Scali's ((NCK)) Sofas 2 Go. OMF is a bedding specialist which currently operates only in NSW/ACT but has potential to increase is footprint. Goldman considers Dare and Le Cornu non-core businesses.

Mark Garwood announced his resignation as CEO recently, effective 20 December 2012. Mr Garwood has been with Fantastic since 2008 and, considering he was the company's steward of growth, his imminent departure was greeted with some trepidation in investor circles. Fantastic is conducting a search for a new CEO. However, Goldman dismisses the concerns as Julian Tertini, managing director and 31% shareholder, and Peter Brennan, finance director and 10% shareholder, remain to anchor the company. Goldman expects any share price weakness as a result of the change in CEO would provide a good buying opportunity, given the company’s positive long term outlook. However, there's still some downside risk to be circumnavigated including any further deterioration in consumer spending/confidence and the failure of the housing recovery to gain traction.

Furniture is one area, probably given its bulky nature, where online retailing is likely to remain small. Goldman says it is still to be proven whether online retailers have a sustainable advantage over bricks and mortar retailers in terms of lower cost structures and therefore lower selling prices. A significant disadvantage for online furniture retailers is the consumer's inability to evaluate such big items in person. However, the internet is the tool whereby consumers undertake research on future furniture purchases and Goldman flags the need for Fantastic to fulfill its intention to develop a full multi channel shopping experience by December 2013.

There are three other brokers covering Fantastic on the FNArena database. These include JP Morgan and Macquarie which have Buy ratings and Credit Suisse which has a Hold rating. The stock carries a consensus target price of $3.14 and consensus earnings growth forecasts of 18.3% in FY13 and 9.5% in FY14. 

 
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