Adairs Confounds Analysts

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Analysts are scratching their heads as to why Adairs’ sales have suddenly collapsed but see value in the stock after Friday’s big share price fall.

-Sales growth mysteriously collapses
-Spending increased to support online business
-Value on offer following share price crash

By Greg Peel

The election result meant franking cash-backs would continue to flow to low tax payers, negative gearing would not be scrapped in the future, if ever, and tax cuts are in the offing. The RBA rate cut, and promise of more to come, eases mortgage stress and puts more money in pockets. All of the above provide support for a weak Australian housing market, and indeed the early signs are that the pace of house price decline is slowing.

Houses need furniture. Why then has Adairs’ ((ADH)) sales growth collapsed to flat in June when it was running at 9% in FY19 to date prior? This news has analysts completely confounded.

Adairs has downgraded its FY19 earnings guidance by -8-12%. Flat sales in June are one reason. Not passing on the full impact of the lower Aussie dollar into prices is another.

But the downgrade also reflects Adairs becoming the victim of its own success. Since deciding to shift focus away from bricks & mortar and towards online, online sales have grown by 40% in FY19 to represent 17% of total sales. This has meant the company’s two distribution centres have been swamped, prompting a need to spend money on upgrades.

That capex will impact on FY20 but will be money well invested, analysts believe, and the benefits of improved efficiencies should be seen by FY21. Yet management has been discussing this requirement for some time, such that Canaccord Genuity feels the impact really should have already been captured by guidance provided as recently as May.

Maybe, Canaccord suggests, the strength in sales growth enjoyed up to that point spurred Adairs into spending a chunk of money it may have been more cautious about if it knew what June was going to look like.

But what did go wrong in June?

It seems not even management is sure, given relatively scant information provided in this update when typically they are a lot more comprehensive. The quantum and speed with which sales collapsed leaves Morgans scratching its head, given June is normally a major trading month.

Canaccord’s channel checks reveal “nothing untoward” regarding unsuccessful product ranges or abnormal competitive behaviour. UBS notes retail trading was subdued to steady leading up the election and while the election does not seem to have provided any turnaround, things don’t appear to be any worse across the industry. Housing categories are soft, foot traffic is down and consumer confidence is weak, but this was the case in May when sales were running at 9% growth for the half.

Morgans suggests it is this ambiguity that led the stock to tank -30% from the open on Friday morning. Lower sales are one thing, particularly after such a strong period, but not knowing why provides a level of that which investors fear most – uncertainty.

To that end Morgans suggests the company will have to reverse its fortunes before the market will feel safe to re-rate the stock. The broker retains an Add rating at the lower level noting that at the close Friday, the stock was offering a 10% yield.

Note that as I write, Adairs’ share price has already rebounded 16%.

Canaccord was set to downgrade to Hold on the guidance downgrade until the analysts saw the share price plummet, and hence a Buy rating is retained.

UBS also cites valuation as the reason to maintain a Buy rating.

Forecasts have nevertheless been cut, and thus so too target prices. Between them, FNArena database brokers UBS and Morgans, the only two covering the stock, have cut their average target to $1.99 from $2.43. Canaccord, not in the database, has cut to $1.60 from $2.32.

Canaccord also throws out a possible explanation for weak sales from left field. It’s already proving to be a bad flu season and winter only began on Friday (solar calendar). Typically August is the worst month for flu and also a seasonally weak month for Adairs, while June is a strong month. Did the flu in June keep everyone in bed?

We shall need to wait for the company’s FY19 result release in August and subsequent guidance update.

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