Robert Stephens, CFA, considers the outlook for Dunelm against a backdrop of an uncertain operating environment.
Home furnishings retailer Dunelm (LON:DNLM) increased its guidance for the 2019 financial year in a recent trading update. The company has experienced stronger than anticipated growth in May and June, which has raised its expectations for the full year.
Although a weak comparator from the previous year may have flattered its results over the last couple of months, the strategy being employed by the business seems to be the main catalyst behind its improving performance.
|First seen in Master Investor Magazine
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Dunelm is seeking to improve the customer experience through a major investment in digital opportunities. For example, it is now utilising tablet-based selling in stores, while also being in the process of implementing a new digital operating system.
This forms part of an increasingly omnichannel approach from the business, in terms of it offering greater flexibility to customers through integrating its online and in-store capabilities. In the third quarter of the 2019 financial year, this led to a 4.1 percentage point increase in the proportion of total revenue that is generated from online sales, with the figure now standing at 18.5%.
Investment in this area could help the business to adapt to a fast-changing retail environment. A decade ago, just 5.7% of retail sales were conducted online. Today, that figure is 18.6%, with online expected to form a growing part of total retail sales over the long run. As such, investing heavily in new technology today could position the business for growth in future years.
As well as an evolving retail environment, Dunelm is facing operating conditions that remain challenging. For example, consumer sentiment has been negative since early 2016 according to the GfK consumer confidence index. Moreover, with the index currently standing at minus 10, there is some way to go until consumers are ‘optimistic’, which would represent a reading of zero.
As such, Dunelm has taken measures to improve margins. For example, it has closed parts of its business and improved sourcing. In the third quarter of the 2019 financial year, these measures led to a rise in gross margin of 90 basis points. Further improvements could reduce its reliance on sales growth to boost profitability in the short run.
Since Dunelm trades on a forward P/E ratio using 2019’s forecast EPS figure of 18.9, there are far cheaper opportunities available elsewhere in the FTSE 350 retail sector. The company, though, seems to be performing significantly better than its sector peers in a tough retail environment, while the investment it is making in the customer experience could strengthen its competitive position over the long run.
Therefore, despite it having gained 84% in the last year, the stock could continue to offer investment potential. Due to an uncertain political and economic environment in the UK, further growth of this scale may not be recorded in the short run. But with an increasingly sound business model that means it is becoming well-placed to capitalise on an evolving retail environment, Dunelm seems to be an appealing opportunity within the retail segment.
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