Interactive Investor

Stockwatch: Bosses back this share with own cash

13th October 2015 09:16

Edmond Jackson from interactive investor

Is homeware retailer Dunelm poised for upside after two years trading sideways?

The price rose strongly in 2012/13 when loose monetary policy fuelled equities. Then, various stocks ran up too far before entering a period of consolidation, and Dunelm's "heavy" share price – in a two-year range of 764p to 1,047p – may have slightly affected sentiment. This relates to a modest 202 million shares issued, hinting at strong cash generation than a need to issue equity for expansion.

The table shows cash flow per share healthily ahead of earnings and Dunelm has grown sales and profit every year since listing in 2006. So it's an established growth share, the question now being whether to pay a fairly full price in terms of PE multiple versus earnings growth rate. Clearly, several of the directors think so: the chief executive designate has just bought £200,228 worth, averaging just over 925p, the senior independent director nearly £20,000 worth at 926p, and another non-executive director £23,600 worth at 944p.

Strong brand reputation in homeware

The merchandise is quite specialist, Dunelm having a particular reputation for bedding, but also for selling curtains, blinds, home furnishings and cookery utensils. The group operates from 149 superstores across the UK with 10 further openings under contract including 2 relocations. There is an aspect of vertical integration following the acquisition in 2008 of the high-quality Dorma bedding brand for £5 million, and the recent purchase of the rights to the Fogarty brand of duvets and pillows.

Both appear exclusive to Dunelm's sales offering with online reviews citing good quality at decent price. It was via Google and strength of online reviews that I twice recently visited one of the outlets – busy soon after opening on Saturdays. Dunelm appears well-organised by way of ability to browse an extensive catalogue online, query customer service, then reserve and collect items in-store (without needing to pay up-front as with some "click-and-collect" operations). Items such as duvets have unpacked samples on display, so customers can see what they are buying.

So I am not surprised to see a healthy revenue trend being reported. September's annual results to 4 July showed like-for-like revenue growth of 5.8% to £822.7 million, up from 2.1%; this on a comparative 52-weeks basis, while the £835.8 million headline figure was based on 53 weeks.

Pre-tax profit rose 4.7% like-for-like and earnings per share around 7% averaging the basic/diluted measures. EPS growth therefore appears modest relative to a PE multiple in the high teens, however Company REFS shows Dunelm trading on an average annual PE around 16 times in 2011/12 rising to over 20 times by 2013/14, so this is nothing out of context and may help explain the stock's recent consolidation phase.

The wider economic context is likely helping Dunelm's recent progress, with UK wage growth supporting more buying of household goods. Strength in the housing market and consumers' renewed willingness to buy on credit helps, too, and the sight of a Conservative majority government also appears to be supporting housing and general confidence. Such factors are probably inter-related.

Capable management heralds "excellent growth potential"

The latest first-quarter trading update cites like-for-like growth up to 9.6% from 5.5%, and total growth up to 21.7% from 12.0% "with all categories showing robust performance" – and the gross margin continuing to improve. This reflects well on the Dunelm brand and management initiatives to refresh the product range, improve seasonal merchandise and create an improved shopping experience. Home delivery is also doing well following the launch of a new website in July: "as the new site becomes fully bedded down, we expect to see substantial further growth through this channel." The directors' share buying came straight after releasing this update.

Historically, the group has been led by Will Adderley who owns 30.6% of the company and became deputy chairman with a separate chief executive appointed. He is currently CEO again following the shock resignation of Nick Wharton, and notably the chief executive from next January will be John Browett, a well-respected retailer who is credited with the turnaround of Dixons and was lately chief executive of Monsoon Accessorise, the shoes and accessories retailer. He cites "excellent growth potential" as a reason for joining Dunelm and underlines this with his share buying. Other high-profile hires include Gavin Chapell from Asda in order to drive multichannel retail growth. Management calibre like this is going to attract some extent of premium in the stock's rating also given they are leading a well-established growth company without issues.

Scope for further special dividends

While the ordinary dividend yield doesn't look material, Dunelm paid out a special dividend of 70p a share last March (equivalent to a return just over 7.5% with the stock at about 940p currently) as the company adopted a new capital policy for net debt – targeting a range of 0.25–0.75 times historic operating profit. "Further special distributions will be considered if net debt falls consistently below 0.25x" – i.e. watch this space.

While not exactly a commitment it realistically raises the prospect of enhanced returns when considering Dunelm's cash flow profile. The last annual accounts show a 13.8% rise in net cash generated from operations, to £118.2 million, with a modest £31.2 million spent on investment and £41.5 million on ordinary dividends – then a further £141.7 million by way of the special dividend. Balance sheet cash was £16.2 million as of 4 July, versus £91 million longer-term debt. However, £673,000 of finance expenses were more than offset by £811,000 finance income, relative to £122.5 million operating profit.

So the context may not look as if another special dividend will happen soon – also in respect of increased capital expenditure in the current financial year, such as store re-fits and a new warehouse – but if Dunelm augments its growth then it's a genuine possibility, as icing on the cake.

For more information see: www.dunelm.production.investis.com

FirstGroup - financial summary
 Consensus estimate
Year ended 31 Mar2011201220132014201520162017
Turnover (£ million)538604677730836  
IFRS3 pre-tax profit (£m)83.696.2108116123  
Normalised pre-tax profit (£m)84.496.2108117 130138
IFRS3 earnings/share (p)29.335.14043.747.3  
Normalised earnings/share (p)29.635.140.144.447.450.354.3
Earnings per share growth (%)10.118.414.310.76.76.18
Price/earnings multiple (x)    18.917.816.5
Price/earnings-to-growth    2.82.92.1
Cash flow/per share36.845.549.651.3   
capex/share (p)18.518.81313.8   
Dividend per share (p)8.51214.516.520.523.425.5
Yield (%)    2.32.62.9
Covered by earnings (x) 2.92.81.12.32.22.1
Net tangible assets per share (p)75.710195.489.4   
Source: Company REFS

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