Nick Scali’s Transitory Freight Headwind

This story features NICK SCALI LIMITED. For more info SHARE ANALYSIS: NCK

Nick Scali’s gross margins have been impacted by materially higher than expected freight rates, but such headwinds should not feature permanently.

-Red Sea issue hits Nick Scali’s margins through higher freight costs
-Sales orders accelerating through the first quarter
-Freight pressures will ease, but not immediately
-UK ramp-up offers significant opportunity

By Greg Peel

Furniture retailer Nick Scali’s ((NCK)) share price took a thumping this week following a trading update at its AGM. The company, which has 128 stores across Australia, New Zealand and the UK, now expects its gross margin for the first half of FY25 to be down at least -2.4 percentage points to 63.6% from the 66.0% recorded in FY24.

FY24 margins beat consensus forecasts at the time.

CEO Anthony Scali explained shipping costs were about five times higher than last financial year, but he hoped these would subside after Chinese New Year in January. The company imports furniture from China, as well as Vietnam, Malaysia and India.

Shipping costs have been rising around the world, returning to levels last seen during the covid pandemic, amid attacks in the Red Sea by Houthi militants. The diversions caused by the attacks have meant ships backing up at important ports in China, Singapore, Malaysia and South Korea.

Chinese data showed transport prices were almost 94% higher than last year in the September quarter. The expectation is nevertheless that upward pressure on freight is likely to decrease, in line with UK and European freight.

But not immediately. AGM commentary implied there have not yet been signs of freight rates slowing or evening out post the material increases in August and September. Given a typical three-month lag between orders and deliveries, margin pressure will continue into the second half of FY25.

Sales the Bright Spot

Nick Scali’s sales across June to September increased by 3.0% year on year, which is positive, but more positive is the retailer turned a -1.2% reduction in sales over June and July into 7.2% growth over August and September to reach that average.

Seeing the acceleration in written sales as a positive indicator into the second half, Macquarie has increased its second half growth forecast to 4% from 1% prior.

Citi believes sales acceleration is more a case of the company improving its marketing and product execution rather than the overall retail market improving. Any reduction in interest rates would be a positive for Nick Scali, and furniture retail in general, given cuts would be a tailwind for housing churn.

Citi has pencilled in February as bringing the first RBA rate cut, but sees a risk of this being delayed to May given the strength of the Australian September jobs data.

May would be appropriate for the first cut, we might consider, given the first rate hike in 2022 also came in May just ahead of the election.

Nick Scali implemented price increases in FY24 but given lags they will take time to impact on earnings, Citi notes. The broker expects management to tread carefully on further price increases in the current consumer environment.

UK on Track

The company is increasing scale from shifting UK volumes to its existing factories. The first refurbishment in the UK should be complete in a month and the company is using its Australian scale to leverage better refurbishment pricing.

The UK benefited from an increased order bank in FY24 delivered in the first quarter of FY25. Nick Scali product is expected to have landed in the UK in September. Macquarie expects sales to accelerate from the second half as more stores carry Nick Scali product.

Management noted recent written sales order margin has improved to be 300bps higher versus margin on delivered revenue. Macquarie expects further margin benefits as Nick Scali product is introduced to stores. This broker’s revised forecasts assume a UK gross margin of 43% in first half and 46% in the second.

Gross margins on A&NZ sales were 63.3%. Something to aspire to in the UK.

Earnings Cuts

In response to margin pressure guidance, Ord Minnett has cut its earnings forecasts by -9%, -8% and -5% across FY25-27 and its target price to $15.00 from $15.50. The broker retains an Accumulate rating but acknowledges there are risks to expectations while freight rates remain unstable.

Macquarie cuts its forecasts by -12%, -6% and -3% over the period and its target to $15.60 from $16.25. This broker sees sales order acceleration as positive and foresees potential improvement in freight rates in the second half FY25, as well as a significant opportunity for the UK region in the medium term.

Macquarie retains Outperform.

Citi’s target is cut to $15.93 from $16.53 following cuts in forecast profit of -19% to -4% across FY25-27. Earnings changes impacted the broker’s target price but there was some offset from higher market and peer multiples.

Citi retains Buy.

Wilsons (Overweight; target $17.30) has equally reduced margin forecasts and thus EPS estimates for the years ahead. The changes come with the following statement: “[…] the gross margin decline is not structural and does not change the long-term Global opportunity for NCK, with meaningful growth drivers in Plush and Nick Scali UK”.

Jarden (Buy; $15.88) is of the same view: “We continue to encourage investors to look through transitory factors and focus on WSO growth plus the longer term UK opportunity, with significant upside risk to NCK’s multiple if it can execute in the UK.”

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