There’s a lot to like about companies that quietly get on with the job of growing earnings and improving the return on each dollar of shareholder funds invested. Companies that, with little fuss or fanfare, consistently deliver in good and bad markets.
Refreshingly, these companies do not have an army of investor relations advisers trying to spin stories or a daily procession of ASX announcements. Their CEO is accessible, there is no fancy office, and the annual report does not look an issue of Vogue.
Better still, their financials have telltale signs. For example, a high, rising return on equity, solid growth in cash flow, low or no debt, and modest share issuance. Their share register often shows a dominant founder or a few early supporters with large equity stakes. The controlling shareholders run the company like a private business, with strong governance.
Nick Scali is an example. I analysed the furniture retailer for The Bull in September last year at $2.97 and noted it was bucking the retail trend with stronger profit growth.
That column suggested waiting for a 10 per cent markdown in Nick Scali before buying, and that occurred in the fourth quarter when Nick Scali fell 12 per cent to $2.63. Patient investors who bought Nick Scali then have watched it rally to $3.59.
Chart 1: Nick Scali
Source: The Bull
More gains are ahead, after a period of share price consolidation. Nick Scali this month reported another strong full-year result. Sales increased 10 per cent to $155.7 million for 2014-15 and after-tax net profit rose 20 per cent to $17.1 million.
The result impressed. Most discretionary retailers would kill for 20 per cent profit growth in a subdued retail climate, characterised by weak consumer confidence and record-low wages growth. Yet Nick Scali, a more-upmarket retailer, posted double-digit sales growth.
Cost control featured. Nick Scali maintained a 60 per cent operating margin, despite the Australian dollar’s continued decline and the impact on import costs. Operating costs as a percentage of sales decreased by one basis points, even though seven stores were opened.
Nick Scali jumped 10 per cent after the result in a falling equity market, driving it closer to fair value. But value still exists for long-term investors and Nick Scali warrants consideration for the small-cap component of portfolios. It has good prospects.
For a start, Nick Scali is strongly leveraged to the housing sector, which is still an economic brightspot thanks to record low interest rates. Rising house prices lifted consumer confidence in the latest Westpac/Melbourne Institute Consumer Sentiment Index.
Within retail, favour companies exposed to housing. Discretionary retailers that rely on fashion or who are more exposed to the threat of online retailing, have a tough outlook. It is no surprise that home owners, who are watching house prices in Sydney and Melbourne post double-digit growth, are buying new furniture or upgrading existing items. A stronger renovations market will also favour furniture retailers.
Nick Scali said trading conditions in July were good and so far in line with expectations. It anticipates continued sales growth in 2015-16 as the full effect of seven store openings in the previous financial year (opened late that year) are felt. Another two store openings in the first half of 2015-16 will also boost growth. It had 45 stores at June 2015.
Faster growth in Western Australia will also drive sales. Nick Scali successfully launched the brand in WA with three stores openings and a distribution centre in 2014-15. A fourth store is planned this financial year.
The biggest risk is further falls in the Australian dollar impacting Nick Scali’s profit margins, although it successfully managed the currency’s fall this year.
Nick Scali is well placed for continued store network expansion. Operating cash flow increased 10 per cent over the year, debt is modest, and the balance sheet shows $33.7 million in cash at June 2015. Like most high-performing small-caps, Nick Scali is able to self-finance much of its growth rather take on huge debt or issue slabs of equity.
Nick Scali’s small size and relatively low liquidity means it is poorly covered among analysts. The two who follow it, in consensus analysts, have buy recommendations and a median $3.65 price target. That suggests Nick Scali is fully valued for now, although the sample size of analysts is too small.
The leading share-valuation service, Skaffold, sees Nick Scali’s intrinsic valuation rising to $3.70 this financial year, $4.09 a year later and $4.51 in three years. That implies an annualised total return (including dividends) of about 15 per cent, more after franking.
Nick Scali is not the market’s most spectacular stock and speculators hoping for huge gains should look elsewhere. But double-digit returns from one of the market’s best-run small companies should appeal to long-term investors who want consistent returns with good upside, and without the frills and fuss.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their financial adviser before acting on themes in this article. All prices and analysis at August 20, 2015.