A growth company priced like a value stock
In early February this year, we wrote a piece on Livewire asking why the market was valuing Dusk Group (ASX: DSK) so cheaply? The company had a less than spectacular debut in late 2020 and subsequently has flown under the radar of many investors. But since listing, Dusk has delivered three consecutive earnings upgrades, with the share price rising around 35% since we published our original article.
As part of Livewire’s reporting season coverage, I have addressed some questions about Dusk’s latest results and explain why we still believe the shares remain attractively priced.
1. Briefly explain what the company does and why you’re attracted to it (at a high level).
Dusk Group is a specialist retailer operating solely within the Australian market. While known mostly for its scented candles, the company's range also includes diffusers, essential oils and other fragrance-related homewares.
Historically, niche homeware retail segments have been largely a cottage industry with a long tail of small boutique merchants fulfilling demand. Dusk is the largest player in the local market, holding around 22% market share, while running only around 122 physical stores in Australia. The company foresee the potential to grow to around 160 stores throughout Australasia by 2024 and also plans to eventually expand into the UK and US markets.
Dusk has a combination of soft and hard factors that make it an attractive investment proposition. The products are orientated towards making homes and offices pleasant environments, which has become exceptionally important given the recent lockdowns. In addition, the majority of the company's products are consumables or products that use consumables. This means that every sale in the present has a high probability of further follow on sales in the future, assuming the buyer remains engaged with the product itself. This confers an enormous advantage over time vs other retail niches.
This "soft factor" advantage translates into hard benefits; for example, the company's loyalty program now boasts almost 700,000 highly engaged members. This translates into exceptional gross margins of almost 70%, while the team has maintained and exercised exceptional capital discipline and allocation decisions. We expect this outperformance to persist over time.
2. How did the current result compare to your expectations? What about market/analyst expectations?
Dusk is a recent listing, only being listed for less than 12 months. In that short period, there have been three consecutive earnings upgrades - something quite unusual. Accordingly, Dusk has outperformed its prospectus projections by a large percentage.
3. Were there any surprises in the result or management’s commentary?
Like all retailers, the first seven weeks of FY22 trade has been impacted by the Victorian and NSW lockdowns. Around half the company's store network is within these two states, but it has only affected top-line revenue by 28%. This relative outperformance demonstrates that the company's products are actively sought by its loyal customers, despite the state lockdowns. This also affirms that Dusk's products are differentiated enough versus competitors for customers to actively seek them out. This is confirmed by the statistic that 60% of the group's revenue by value is derived from Dusk rewards members
4. What do you think is the most important thing for investors to know about this company?
There is significant potential for Dusk to expand overseas. The management team is very disciplined in allocating capital and is taking a careful, prudent approach given the uncertainties around COVID and international travel. However, we expect that once the present situation normalises, the company will commence its international expansion.
5. What’s your outlook for the company?
While like-for-like growth sales are down slightly, we anticipate that Dusk may be able to achieve at least 80% of FY21's revenue, while maintaining an EBIT above $30 million. This assumes that social restrictions are loosened in Victoria and NSW prior to the Christmas shopping period, as well as being open during the key Mother's Day trading period. The company has also disclosed that "reopening" events generally have a large positive impact on physical stores' trading.
The company’s initial foray into New Zealand has been delayed by covid induced travel restrictions, and we believe there is significant scope and potential to begin examining larger international markets such as the UK and US for near-term expansion, despite the delays being experienced within the ANZ region.
6. Do you still think the company looks attractive following the result (and the price response)? Why or why not?
We believe that Dusk looks highly attractive at the current valuation. The company has a number of highly attractive factors that are conducive to future returns. These are:
- zero leverage,
- high margins and cash generation,
- global expansion potential,
- broader tailwinds for their specific sector, and
- an aligned and disciplined management team.
The company looks highly undervalued when you examine its valuation on a peer comparison basis.
Additionally, it has paid a gross yield (including franking credits) of around 11% over the past financial year, based on today’s price. We expect the company to continue to pay a sustainable, reliable dividend stream in the coming years, while holding significant upside potential from further expansion in its activities.
We consider the fair value for Dusk to be around $5 a share, considering all the factors mentioned above. In a nutshell, similar to our original thesis, we consider Dusk to be a Growth company that's priced as a Value stock.
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Emanuel is the Principal of Datt Capital, a boutique Melbourne-based investment manager focused on identifying high growth and special situation opportunities.
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