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Questor: there’s much to like at Dunelm but a high valuation leaves little room for error
Questor share tip: while the board is doing a good job, paying a fat multiple for a business in such an unpredictable sector is rarely a good idea
Given all the fears over the economy, soggy consumer confidence and the ongoing onslaught from purely online rivals, it may surprise investors to learn that the general retailers sector is the third best performer so far this year of the 39 groupings in the FTSE All Share index.
The biggest riser within the sector is Dunelm, the homewares and furniture chain. The shares have gained 60pc this year alone, helped by February’s interim results, which reported underlying sales growth at both the bricks-and-mortar stores and online, to embellish the company’s credentials in multi-channel retail.
Under Nick Wilkinson, the chief executive who took over in February last year, the company has closed its Kiddicare and Worldstores websites to focus on the core Dunelm brand. Careful cost control, better sourcing and a tighter grip on Worldstores, bought in 2016, boosted margins and profits, allowing the board to recommend a 7.1pc increase in the dividend.
Net debt also remains low at £73m, although we must not forget the £400m leasing payments to which Dunelm is committed on its stores. Even if the contracts can be reviewed every five years the annual leasing bill was £51m in the last financial year, a significant sum for a firm that made an operating profit of £96m after exceptional items.
Overall there is much to like here, but there is one problem. This year’s share price romp leaves Dunelm trading on more than 19 times forecast earnings for the year to June. Shares in Next, whose own 40pc share price surge is doing this column a welcome favour, can be purchased at nearer 13 times earnings.
While they are not directly comparable, both must deal with the vagaries of consumer preferences, currency movements, the British weather and more besides.
Paying fat multiples of earnings for businesses exposed to such unpredictable elements is rarely a good idea and Dunelm now comes on a big premium both to rivals and to the wider London stock market.
Valuation is never a catalyst on its own but this year’s advance means expectations are high and there is little room for any disappointment. We said hold in October 2016 but it’s now time to sell, despite the management team’s good work.
Questor says: sell
Ticker: DNLM
Share price at close: 880p
Update: JPJ Group
Our flutter on online bingo firm JPJ has yet to bring any returns: the shares have lost some 15pc since our initial look in October 2017, thanks to increased taxation and greater regulatory scrutiny of online betting in Britain.
However, it should be worth persevering with the stock: it still looks cheap on barely seven times forecast earnings, debt (and therefore risk) is coming down and there is still the chance that good cash flow will ultimately translate into dividends or share buybacks.
March’s full-year results were perfectly satisfactory, with welcome signs of stabilisation in Britain and an acceleration in sales growth in the overseas casino operation, Vera & John. A shift in the sales mix away from the UK will probably do little harm and the sale of the Mandalay Bay bingo business will allow the experienced management team to focus on stronger, better-established brands.
Earnings growth expectations remain modest and any cash returns could be the catalyst to spark interest in the stock.
Questor says: hold
Ticker: JPJ
Share price at close: 676p
- Read Questor’s rules of investment before you follow our tips. See Questor's tips every day at twitter.com/DTquestor
Update: Xaar
Oh dear. This column’s faith in Xaar’s technological prowess remains undimmed as the company is a leader in digital inkjet printing, but our assessment of the Cambridgeshire firm as a potential turnaround play last summer is looking poorly timed.
Last month’s full-year pre-tax loss of £12m lived down to low expectations and knocked a big hole in the net cash pile that we were relying on as a buffer. It is down to £28m and management’s acknowledgement that Xaar now needs a strategic partner to help it fulfil its potential is of grave concern.
Unfortunately, it is time admit our error and accept the damage.
Questor says: sell
Ticker: XAR
Share price at close: 86.7p
- Questor archive: telegraph.co.uk/questor
Russ Mould is investment director at AJ Bell, the stockbroker. For the best of the Telegraph's investment analysis, advice and expert opinion, sign up to our weekly newsletter.