Shares in homewares retailer Dunelm (DNLM) were marked down in July despite raised profit guidance, as plans to ramp up investment spend spurred some investors to take profit after a phenomenal run.

Yet the pullback proved short-lived, as the cash-generative curtains, quilts and kitchenware purveyor topped the FTSE 250 after rolling out (8 Sep) superb results for the year ended 26 June 2021 and upgrading profit guidance for the new financial year.

Having returned to the dividend list at the half-year stage back in February, the Leicester-headquartered retailer declared a special dividend of 65p on top of a 35p annual ordinary payment, demonstrating management’s confidence in the growth prospects and cash generation of the business.

While retail rivals and many UK fund managers certainly appreciate the competitive strengths of Dunelm, it is fair to say it hasn’t got quite the same profile among investors as say, Simon Wolfson-steered Next (NXT) or Peter Cowgill-guided JD Sports Fashion (JD.), but that appears to be changing under the leadership of digitally-savvy CEO Nick Wilkinson, who took the helm in 2018.

DUNELM’S RISE

So where has Dunelm come from and what makes the business so special? It was founded in 1979 as a market stall selling ready-made curtains by the Adderley family, opened its first shop in Leicester in 1984 and its first superstore in 1991.

In the intervening years, Dunelm has developed into the UK’s homewares market leader. Present-day Dunelm sells keenly priced-yet-quality home furnishings through 175 predominantly out-of-town superstores and the dunelm.com website.

From its textiles heritage in bedding, curtains, cushions, quilts and pillows, the company has also Dunelm has broadened its range into furniture, kitchenware, dining, lighting, outdoor, craft and decoration. It now sells roughly 50,000 product lines include value-for-money own brands and also sources and sells quality labels such as Dorma and Fogarty.

Floated on the London Stock Exchange in 2006, its market cap currently stands at almost £3 billion. The Adderley family still controls 42% of the equity, with Will, the son of founders Bill and Jean, sitting on the board as deputy chairman.

MEASURES OF QUALITY

For the year to 30 June 2021, pre-tax profits powered 44.6% higher to £157.8 million on total sales up 26.3% to £1.34 billion, despite its bricks and mortar stores being shuttered for more than a third of the financial year thanks to pandemic-induced lockdowns.

Investments previously made to develop Dunelm’s digital capabilities enabled the retailer to respond quickly to the bumper online demand for homewares and DIY induced by the pandemic, including through its click & collect proposition, which offered customers safe and friendly service throughout most of the restricted trading periods.

According to GlobalData, Dunelm’s UK homewares market share grew by 1.6% to a still-modest 9.1% last year, implying there’s plenty of room to grow in the years ahead.

One fervent fan of the business is Guy Anderson, fund manager for investment trust Mercantile (MRC), who says: ‘Why we’re invested in this business is they are a leading operator in the homewares market focused completely on the UK’.

Anderson explains the catalyst for initially investing in Dunelm in February 2019 was ‘really the work that Nick and his team were doing in putting forward their customer first strategy, which is all about retaining the value-for-money credentials of Dunelm, whilst increasing their product proposition and working very hard on their distribution capabilities’.

Building on its physical store base, Anderson says Dunelm has been made ‘fit for purpose in the 21st century’ under Wilkinson and his team, who have ‘put in place a lot of things that we probably all take for granted such as the ability to buy a product online.

‘Lots of things that sound simple but are quite complicated to actually put in place, but they’ve done a fantastic job and what that has done is has really broadened the customer base,’ he adds.

Anderson is palpably excited by the journey Dunelm is on, which is ‘all about increasing customer frequency. It is not about trying to get people to pay more for the same product, it is about selling more items to more people and they’ve driven tremendous growth in profits over the long term.’ Anderson thinks the outlook is for ‘pretty good growth looking ahead’.

He points out the retailer remains good value too, since it is generating ‘around a 6%-to-6.5% free cash flow yield on a steady basis with fantastic drop through of accounting profits to cash, which is ultimately the most important thing’.

STRONG MARGINS

In common with the industry, Dunelm is seeing some supply chain disruption and inflationary pressures from raw materials, freight costs and driver shortages. However, the business generates high gross margins north of 50%, which should it to cushion some of the impact of these cost pressures.

So long as it isn’t impacted by further Covid-related restrictions, Dunelm confidently expects that pre-tax profits for the year to next June will be ‘modestly ahead’ of the top of the £153 million-to-£175 million range analysts previously had pencilled in.

This follows ‘encouraging’ sales growth in the first ten weeks, including a positive response from customers to its summer sale in July and with ‘continued outperformance versus the homewares market’.

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