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Does the long-term outlook for Nick Scali remain strong?

Nick Scali Limited (ASX: NCK), a leading player in the furniture industry, and among a handful of ASX-listed companies we would rank as “A1” in terms of quality, demonstrated confidence in its financial and strategic trajectory during its recent Annual General Meeting, shrugging off concerns over the post-pandemic economic landscape.

The company’s resilient trading update for the first quarter offered guidance for 1H24’s net profit after tax (NPAT) which beat expectations.

Supported by rising house prices, immigration, and market-share gains, and despite experiencing a downturn in July, where group written sales orders dropped by 8.1 per cent compared to the previous year, the company reported full first quarter group written sales orders down 5.4 per cent. The company also anticipates a 1H24 NPAT between $40-42 million, which is 14 per cent ahead of consensus estimates and likely buoyed by robust gross margins and stringent cost control, as well a more modest sales decline of around four per cent in August and September.

This resilience is commendable considering Nick Scali’s acknowledgment of May as an exceptionally challenging trading month. Encouragingly, the company has now witnessed a steady improvement in trading for approximately five months.

These positive trends coincide with the last interest rate hike on 7 June, suggesting the absence of any further rate hikes could mean the worst is behind Nick Scali.

The company’s assertive response to the challenges presented by the last interest rate rise on 7 June, which notably impacted trading conditions, has been a testament to its strategic resilience. The sequential improvement over the past five months underscores the firm, and management’s skill at navigating fluctuating market dynamics as well, highlighting its competitive advantages.

Amid this favourable backdrop, speculation around Nick Scali’s expansion strategies is rife, particularly concerning potential mergers and acquisitions (M&A). The Chairman’s statement, “The Board will continue to assess strategic opportunities to grow the existing business and will consider investment opportunities which can deliver attractive returns for shareholders” highlighted the board’s commitment to seizing growth-enhancing investment opportunities.

Analysts suggest that the recent Plush acquisition’s successful incorporation could pave the way for further strategic acquisitions, arguably boosted by CEO Anthony Scali’s previous remarks on the attractive synergies between the Australian and UK furniture markets.

Importantly, while Nick Scali is charting its own optimistic course, the broader industry continues to experience headwinds that could impact the company if they deepen, including a post-COVID decline in consumer demand, resultant inventory oversupply and predictably, margin-damaging price discounting and promotional activity.

Nick Scali does face other external pressures, including fluctuating freight costs. These spiked during the pandemic and represented up to 35 per cent of the cost of goods sold (COGS). Additionally, pressure on wage inflation and rent are ongoing considerations.

An investment in Nick Scali isn’t without risk. Operationally, the integration of the Plush acquisition, potential future supply chain disruptions, geopolitically charged fuel prices, and the possibility of a recession as well as the impact on share price multiples from interminably rising bond interest rates need to be considered.

The long-term outlook for Nick Scali’s business remains strong, bolstered by its many competitive advantages. The company is expected to continue its momentum, capitalising on store rollouts and its acquisition-enhanced market position. Meanwhile, assuming a sustainable rate of return on equity of 32 per cent (which is lower than forecast), a 70 per cent ongoing payout ratio and a nine per cent required return, the estimated value of the business is about $13.00 versus a share price of just under $10.70. 

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