"We are confident that we will emerge from this crisis as a stronger business ready to return to sustainable and profitable growth." Nick Wilkinson (CEO, Dunelm, 16th April 2020)
I have spent a lot of time writing about theory since I started writing my blog back in January 2020. My initial intention had been to take readers on a walk through approach and practicalities, spending a lot of time initially on psychology, then methodology. The rapid change in temperature of the Market at the back end of February 2020 caused me to change direction in my writing. I've written a lot recently about how we can respond as investors in times like these. It was always my intention to move on to application sooner rather than later. I'm now going to start applying some of the theory to real life situations.
As my first company in focus, I thought I'd look at Dunelm (DNLM). I hold no position in it and I don't tip (or am qualified to do so)*. I write simply to educate. However I cannot deny that it is a company that has piqued my interest for some time. The drawback has however been price; it's usually been too expensive for me.
Dunlem has however been hit hard by the Market Crash. It was trading at £7 per share on 20th March 2020. It had hit £14 per share on Valentine's day, only 5 weeks before off the back of a very good report to the Market. What had happened? Well, a lot of shares got sold off heavily in the Panic and certain shares (oil producers and retailers) got hit especially hard. They were seen as the riskiest plays as the Market took a downturn and the sell-off was indiscriminate. It didn't matter how great your business was. If you were in the wrong sector demand for your shares, they slumped.
Dunelm came to my attention as it was one of those retailers that was favoured by my wife. My wife is (by her own admission) a savvy shopper and recognises the benefit of both quality and value. For homewares and furnishings Dunelm rapidly became her number one choice at the expense of the older players (the Department Stores) and the new pretenders (Supermarkets etc.) Only John Lewis came close and you can't buy shares in John Lewis. Legendary investor Peter Lynch writes in his classic One Up on Wall Street that advice from his wife's shopping habits led him to discover great companies on more than one occasion. Of course following this approach alone is not recommended, not least as retail is more brutal than ever as a sector, but the truth is that there will always be some great finds out there and it really isn't a bad place to start.
So why did I like Dunelm when I started to look into it?
- Balance Sheet- Appreciating amount of cash on balance sheet; growing amount of Work Capital (impressive for a high turnover cash retailer); sensible gearing (levels of net debt). Sensible management of lease liabilities.
- Growth- increased revenues year on year, growing levels of earnings per share, improving operating margin.
- Dividends- progressive dividends policy, with reasonable coverage by earnings
- Quality- (a key metric for me) a return on capital of over 30%
- Good management- evidence of a strong team in charge with clear focus on tight and focused management of the business
- Strategy- constantly reporting ways in which they are looking to improve the earnings in the business. A good move to online retailing (key to survival for most retailers).
- Consumer demand- potentially quite a recession proof business as they sell everyday items that are needed through good times and bad.
- Competition- main competition seemed to be the Supermarkets (who lack focus on this area and often seem to be more focused on price than quality) and Amazon (who lack the obvious deficiency of physical stores and the need for the item "today" with price being less and less of a factor)
- Position in FTSE- comfortably in the FTSE250 and therefore picked up by Indices
- Decent Healthcheck scores- both Pitroski F-Score and Altman Z2 Scores (Source: Stockopedia)
The main problem for me was the P/E (Profit to Earnings) ratio. It was simply too high. Anything over 20 has (in my very rough estimation) much less wriggle room if things start to go wrong. That's not to say I haven't bought shares on such warm valuations and done well. They usually tend to be very high growth prospects though.
So would I be tempted in now?
The shares are definitely a lot cheaper than they were, so if you really believe in the story then they are as a prospect arguably less risky than they were.
I really liked the Company's statement to the Market on Thursday 16th April 2020. The top management have taken pay cuts. They have made sensible moves to use Government schemes to protect jobs, they have a strategy to re-open some stores safely, their online business is doing well. They have also protected their working capital really well by drawing their full £175m revolving facility and keeping it unused but ready to deploy. As a result the Company will be able to survive a prolonged lockdown.
Looking at the charts today (18th April) both RSI (Relative Strength Index) and MACD (Moving Average Convergence Divergence) look fine. The Share Price is now £8.84, so why Dunlem is not quite the bargain it was on 20th March, it is still only at 62% of its February 2020 high.
On a general level I am nervous about deploying my cash reserves too liberally at present. I can foresee more Market trouble ahead. However there are opportunities to buy quality in times like these and in my humble view Dunelm fits the quality bill at present.
Stay safe and always do your own research.
* This blog is written subject to the usual disclaimer.