Brokers Highlight Potential In Adairs

This story features ADAIRS LIMITED. For more info SHARE ANALYSIS: ADH

-Control of vertical market
-Healthy margins
-Expansion opportunities
 

By Eva Brocklehurst

Home furnishings retailer Adairs ((ADH)) is a beneficiary of a housing cycle in an upswing, with fashion and decorator sales now making up half of its turnover. The category is outperforming the rest of the discretionary retail sector in Australia because of the strong number of housing completions.

Having recently listed on ASX, Morgans lauds the company’s potential for upgrades to prospectus forecasts with strong growth versus its peers. Complete control of a vertical market is a help, as costs and pricing can be managed, which the broker considers critical in an environment of a falling Australian dollar. Morgans initiates with an Add rating and $3.11 target.

Adairs is a retailer of home furnishings with a national footprint. There are 131 stores in a number of formats and a small, but growing, online presence. Most of the product is private label brands with the company controlling design, manufacture and sales such that it can respond quickly to changes in trends while margins are maximised.

Sales growth has been around 12% per annum from FY12-14. Morgans believes this can easily continue and forecasts 18% sales growth to FY16, underpinned by store rollout and margin expansion. With more money in consumers’ pockets because of low interest rates the wealth effect drives confidence, while the housing backdrop means new purchases are required to fill new homes – all upside for Adairs.

UBS is also an enthusiast, noting the company enjoys support from strong household goods spending with opportunities to expand its addressable market. The company expects to lift its store openings to 8-12 per annum over the next five years.

Risks in the near term are the rollout of a new point-of-sale system in the second half of FY16 and the FX impact on costs. UBS, in monitoring the currency sensitivity, notes every US1c fall in the Australian dollar below US75c affects FY16 pro forma earnings by a negative 1.1% without offsetting price rises. Any macro economic slowdown could magnify these risks.

Long term the risks are a maturing of the category while strong sales growth and earnings margins could attract new international entrants. There is a risk of failure in emerging formats and offshore markets but also upside if the company opens more core format stores domestically and in New Zealand or South Africa.

The broker acknowledges the latter two markets are not growing spending on household textiles as fast as overall consumer spending but there is an opportunity for Adairs to exploit, as the homewares “fashion” trend appears to be relatively immature. Moreover, the broker highlights the positives in that both are in the southern hemisphere and other brands have had some success leading the way. UBS initiates on Adairs with a Buy rating and $3.25 target.

Goldman Sachs is more circumspect. While accepting the company is a leading specialty retailer of homewares in a strong market the broker initiates coverage with a Neutral rating on valuation grounds as the stock is trading close to its 12-month target of $2.85, which is based on a 10% price/earnings premium to the small cap industrials ex finance.

Earnings margins over a two-year average are 15.8%, which the broker compares to the domestic retail median of 10.2%. The high margin and vertically integrated model supports high returns, in Goldman’s view. The core driver of growth will be the vertically integrated model, design capabilities and online investments, which should enable the company to win market share. Still, Goldman Sachs also cites increased competition as a risk, particularly from international entrants and online.

The broker estimates the company has around 12% share in a relatively fragmented market. Competition, particularly in its Staples business, is price based. Moreover, the barriers to entry are moderately low, Goldman Sachs observes, and a number of large global players have recently opened in Australia. While their impact has been limited to date they may be strong competitors in the future.

The broker also considers the lower Australian dollar to be a material headwind for gross margins in FY16. In order to manage this impact the company takes out forward cover up to 12 months in advance. Goldman Sachs is also not so sure retail spending can continue at its current pace. The broker’s economists forecast the current level of housing shortage should persist until 2016 before easing back as interest rates normalise and population growth slows.

While the housing sector has been robust and favourable for household goods over the past two years the broker highlights growth in retail sales and wages is below trend and consumer sentiment is fragile. If housing activity starts to slow this could negatively affect demand for the company’s products.

Adairs has several different formats besides its Adairs stores, such as Adairs Homemaker, a larger format with the widest range of bulky goods, Adairs Kids, which targets children’s bedroom products, and Urban Home Republic, a home decorator range which is now a store format. Clearance outlets complete the mix. The lease terms for the stores are broadly consistent with specialty retail peers.

The company also has 370,000 members in its paid loyalty program called the Linen Lovers Club. The majority of product is sourced from China but increasingly also from Vietnam, Bangladesh, India, Portugal and Turkey. Adairs is expected to focus its store roll-out in NSW and Queensland where it is relatively underweight compared with the population. The first Adairs store commenced trading in 1918 in Prahran, Victoria, and the footprint was expanded in the 1990s to include all mainland states.
 

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