Adairs – real estate turnover AND slowing consumption
The Australian homewares retailer Adairs Limited (ASX:ADH), is currently confronting the forces associated with a slowdown in foot traffic at its stores and a decline in online traffic due to declining consumption and falling turnover in residential real estate.
Reflecting its earnings sensitivity to a sudden decline in store traffic, Adairs recently downgraded its guidance for FY23. The highly discretionary nature of the homewares category amplifies the risks associated with investing in haberdashery retailers ahead of a possible recession and while interest rates are still rising. Elevated inflation and consecutive interest rate hikes have impacted consumer spending, resulting in a slowdown in foot traffic to stores and reduced online visits.
Adairs reported a significant decline in sales over the past few weeks, contrasting with the solid performance observed in the first half of FY23 and the initial part of the second half. In the first seven weeks of the second half of the current financial year, group sales were up 1.8 per cent. However, by the end of the first 21 weeks, sales were down by seven per cent, indicating an average decline of approximately 11 per cent in weeks 8-21. This abrupt slowdown has been experienced in all divisions, including Adairs, Focus, and Mocka.
Meanwhile, operating leverage poses a significant challenge for retail businesses like Adairs. The fixed operating cost base remains unchanged in the near-term while revenue fluctuates. As a result, a sales slowdown can have an amplified impact on profitability. The recent downward revision to revenue guidance of zero to seven per cent translates to a reduction in earnings before interest and taxes (EBIT) guidance of 7-23 per cent, highlighting the impact of operating leverage on Adairs’ financial performance.
Generally, analysts have downgraded their forecasts, reflecting their more cautious outlook for the company. Lowered estimates for FY23 and expectations of intense pressure on earnings in FY24 have led to a reassessment of projections and an earnings multiple de-rating. While Adairs can be expected to explore a rationalisation of its operating expenditure, the volatile and unpredictable nature of near-term earnings understandably triggers caution among the investment community.
Analysts have revised their valuations, and despite the appeal of a circa seven per cent dividend yield for FY24, the volatility in near-term earnings has led to a reduction in target prices. Adairs’ share price is 53 per cent lower than its February 2023 high and the stock now trades on an FY24 P/E ratio of nine times Earnings Per Share. While that seems cheap compared to history, we remind investors that low to mid-single-digit P/Es are not unusual for discretionary retailers ahead of and during a recession. Adairs faces intense pressure on its FY24 earnings so investors should be cautious about future downgrades given some analysts currently have EPS for FY24 falling less than four per cent.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
