A high equity rating leaves the retailer’s shares vulnerable to a big correction if there are problems stocking its stores
Thursday 20 Feb 2020 Author: James Crux

Shares in homewares market leader Dunelm (DNLM) have surged 148% higher since the start of 2019 thanks to a series of positive trading updates. Its latest half year results, published on 12 February, show the benefits of a recently-upgraded digital platform which has made it easier for customers to buy goods online.

The key challenge for investors is to decide if the stock has become too expensive or whether it actually deserves to trade on a premium rating. We can see a clear risk to its supply chain in the near-term and so the rating makes the stock vulnerable to a large share price correction upon the slightest bit of bad news.

In Dunelm’s defence, it is clearly doing something well to enjoy strong earnings momentum. However, the valuation looks rich for a retail business with a large physical store estate. At £13.40, it is trading on 24.5 times forecast earnings for the year ending June 2020. In comparison, Next (NXT) trades on 15 times expected earnings for its financial year ending January 2021.

In the second half of 2019 Dunelm’s like-for-like sales grew by 5.6% despite demanding comparatives and a soft homewares market, and gross margins improved thanks to sourcing gains and fewer markdowns.

Online sales grew 33% in the first half as Dunelm’s strong multi-channel business and click and collect proposition increased footfall to stores.

Admittedly the retailer’s wares aren’t everyday essentials, but a recent pick-up in the housing market with higher prices offers an earnings tailwind, since it indicates stronger activity in the property space. People moving home is a natural catalyst to buy new homeware items, such as those offered by Dunelm.

Broker Shore Capital insists Dunelm is ‘starting to leverage its scale in a highly fragmented market from John Lewis and others given their recent travails’, and broker Peel Hunt says the business has ‘significant growth potential ahead’.

Risks to earnings forecasts include additional pressure on disposable incomes should the economy turn down, homeware category expansion by competitors and unseasonal weather.

But perhaps the biggest risk is China being locked down by the coronavirus and how that could disrupt supplies.

Investment bank UBS points out that 17% of Dunelm’s goods are sourced directly from China. It therefore feels prudent to assume there will be some supply chain disruption and that the shares are priced too high to warrant buying.

We like the business and believe the best approach is to wait for any large pullback in the share price before buying.

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