Household goods and furniture retailer Dunelm (DNLM) only relaunched its digital platform in October 2019. Going digital was the right strategy given the growth of e-commerce, but previous attempts to get there had not worked well. The 2016 acquisition of online retailer Worldstores was unsuccessful, with losses mounting and the company’s websites eventually shutting down. But Dunelm has proven that it is possible to learn from your mistakes. The digital revival has turned out to be a second chance, and in more ways than one. Just two months after the commissioning of its new digital systems, the first case of Covid-19 was discovered in Wuhan. A few months later, the UK government introduced its first lockdown, forcing Dunelm to close the doors of all of its stores.
If the hackneyed proverb that necessity is the mother of invention is truly true, then it seems to work its magic in Dunelm. For fiscal 2020, digital represented 27% of sales. At the end of its 2021 fiscal year, it was 47%. It’s an incredibly fast transformation.
Digifirst of all
The company has focused on a fleet of 175 physical stores, but Dunelm is now focused on online growth. Bricks and mortar are still important. The company continues to target three to five openings per year while ramping up redevelopments following the slowdown in store improvement activity during the lockdown. However, management believes that greater opportunities are available by exploiting the insights of digital data.
Initiatives the company is working on to drive digital sales include improving click & collect options, which comes with a three-hour pledge, increasing order fulfillment speed, and increasing the proportion of orders classified as “perfect”. Improving after-sales communications and resolving problematic orders are other areas of interest. And the company is looking to improve its product lines, including focusing on product sustainability and offering in-store recycling.
One of the main goals of these efforts is to increase the number of high value-added customers – the 12% of buyers who account for two-fifths of sales.
Importantly, there is plenty of evidence in the annual figures released by the company earlier this month that things are moving in the right direction. Although Dunelm’s stores were only fully open for 65% of last year, revenue jumped 26% while pre-tax profits were up 45%. This is largely due to a 115% increase in online sales. And underpinning how impressive the group’s performance has been in its fiscal year ending June 2021, management estimates Dunelm’s share of the fragmented £ 25bn housewares market has increased from 7. 7 to 9.1%.
Inasmuch asity and growth
The strong performance last year was exceptional and certainly benefited from the moment when Dunelm set up its action online. However, this is not just a flash in the pan. Since 2015, Dunelm’s annual revenue has grown 60% from £ 836million to £ 1.37 billion. This included almost constant year-over-year growth with the exception of 2020 where there had been a slight drop due to store closings during the lockdown. In addition, despite a slight blow from the unfortunate acquisition of Worldstores, the business has always been very profitable. Indeed, the return on capital employed (ROCE) – a measure of profit in relation to the investments made to generate it – amounts to more than 30%.
Gross margins, a key measure of a company’s pricing power, are also high. Dunelm makes affordable products, but thanks to long-standing and strong supplier relationships, the cost of production is also low. Its gross margin in 2021 was 51.6%, compared to 50.3% in 2020. It has not fallen below 48.0% since 2015. For comparison, IKEA, which is an unlisted company of affordable household goods and furniture, had a gross margin of only 20% in 2020. It also compares very well to other listed consumer companies (see graph).
Dunelm’s pricing power was also manifested last year in its decision to cut winter sales and postpone its summer sales. None of this did much to detract from its impressive market share gains.
The strength of the group’s pricing power and supplier relationships is also evident in the company’s outlook. Managing Director Nick Wilkinson said the company is experiencing “continued supply chain disruption and inflationary pressures from raw materials, freight costs and a shortage of drivers.” All of these problems, coupled with rising wages due to a workforce shortage caused by the pandemic and Brexit, are expected to squeeze its margins. But despite these headwinds, improving supply means gross margin is only expected to decline between 0.5 and 0.75 percentage points in the current year.
Dunelm is also very good at turning his profits into cash. The impressive improvement in gross margin in 2021 helped it increase its operating profit by 43% for the year, from £ 116million to £ 167million. Of this operating profit, £ 184.2 million was converted to net operating cash flow (after tax), a conversion rate of 111%. After capital expenditure and payment of lease debts, its Free Cash Flow (FCF) stands at £ 108.5m. And cash flow for the year was actually depressed due to the crazy swings in working capital caused by Covid, which saw the group run out of stock in 2020, which pushed the FCF that year up to £ 174million, with the opposite impact in 2021.
After ending the year with net cash up £ 45million to £ 129million, which excludes lease liabilities of £ 293million, the company decided to distribute cash to the shareholders by paying a special dividend of 65p in addition to the base payment of 35p. While the company withdrew its dividend during the foreclosure, it has a past form of making large special dividend payments and broker Peel Hunt believes another special payment could bring the total dividend this year to around 90p, this which equates to a yield of about 6%.
A ffamily affair
The timing of the digital transition was fortuitous, but it is often the forward-thinking companies that profit from the fortune. Part of Dunelm’s willingness to look to the long term and his ability to cope well with setbacks, like Worldstores, could be related to the fact that this is a mostly family-owned business. Pictet Asset Management found that family businesses (30% more owned) outperformed non-family businesses by 56% between January 2007 and June 2020. Dunelm was founded as a market stall in Leicester in 1979 by the husband and wife team Bill and Jean. Adderley and the family still own more than half of the £ 3 billion company.
Family businesses have historically outperformed the market as a whole because of their willingness to look beyond the next round of analyst calls. Instead of worrying about the ups and downs of fickle markets, they are instead motivated by the abandonment of a well-run business for future generations. Family businesses are also often good dividend payers. Dunelm seems to do the trick.
But while a focus on family may help Dunelm aim for the long term, the pandemic has undeniably increased demand for housewares and furniture over the past year. Many white-collar workers had to order desks and office chairs, and the buzzing real estate market meant there was an above-average amount of decorating. But the real estate market could already slow down with the 73,740 residential transactions in July 2021, down 62.8% compared to June 2021. Comparators of sales for next year could be tricky.
Additionally, increasing digital sales doesn’t always mean overall sales will increase. They risk cannibalizing in-store sales. The business needs to find a way to reach new customers with its digital product rather than just serving loyal customers who previously shopped in person.
Despite these concerns, Dunelm is far from being the market leader. Sales in the first 10 weeks of the new year have been “encouraging” and the board expects pre-tax profit to be slightly higher than analysts’ expectations this year. Following last week’s full year results, the pre-tax profit consensus has been revised up from £ 166million for the current year to £ 177million.
Dunelm’s share price jumped 13% on the day of its earnings. We see this as an encouraging dynamic rather than a foamy speculation. Stocks do not look expensive at 21 times expected earnings for the next 12 months given the quality of the business, its growth potential and the likelihood that Dunelm will continue to deliver large wads of cash.
|Company details||name||Mkt cap||Price||52 weeks Hi / Lo|
|Dunelm (DNLM)||£ 3.04 billion||1500p||1,601p / 1,114p|
|Size / Debt||NAV per share *||Net cash position / Debt (-)||Net debt / Ebitda||Operating cash flow / Ebitda|
|139p||– £ 165 million||0.7 x||65%|
|Evaluation||Before PE (+ 12 months)||Before DY (+ 12 months)||FCF Yld (+ 12months)||VE / Sales|
|Quality / Growth||EBIT margin||ROCE||5-year sales CAGR||TCAC EPS 5 years|
|Forecast / Momentum||Fwd EPS grth NTM||Before EPS grth STM||3 month old mom||% change in EPS before 3 months|
|End of year June 30||Sales (£ bn)||Profit before tax (£ m)||EPS (p)||DPS (p) *|
|Source: FactSet, adjusted PTP and EPS figures|
|NTM = next twelve months|
|STM = Second Twelve Months (i.e. in one year)|
|* excluding exceptional dividends of 32p in 2019 and 65p in 2021|