The new year has been rough on ASX-listed retailers, and Adairs Ltd (ASX: ADH) shares haven't been immune to the pain. They've seen their value plummet 20% since the start of 2022.
However, The Motley Fool analyst Drew Flowers has seen through the homewares and furniture retailer's recent pain, narrowing in on what he thinks is a strong buying opportunity.
Flowers sat down with our chief investment officer, Scott Phillips, to talk over the pros and cons of Adairs stock this week.
The conversation is part of The Motley Fool's Stock of the Week series. This week's stock pick, as well as past picks, can be found on our YouTube channel.
Readers can also find this week's stock pick here and in podcast form – alongside The Motley Fool's other audio offerings – here.
At the time of writing, the Adairs share price is $3.24.
Let's see why Flowers thinks now's the time for investors to take a good look at Adairs.
Why Flowers isn't worried about the Adairs share price tumble
While the Adairs share price has had a rough trot into 2022, the analyst isn't concerned. He says:
Over the past 24 months [retailers have been] very sensitive to people's expectations about reopening, or closures, or online sales, or in-store sales, and [Adairs'] shares did take a take a bit of punishment with the trading update.
The trading update in question — published in late January — outlines the company's performance over the first half of financial year 2022. Its release caused the Adairs share price to crash 21.5%.
"Now, the first half was not their best, let's put it that way," Flowers conceded. "The margins were under pressure. But, also, the stores were closed for an incredible amount of time.
"Even managing staff is extremely difficult [during outbreaks]. People had to isolate, some people were infected of course… their morale is not particularly high either."
"But what was impressive: the online sales were strong, they were bigger, slightly higher than the previous year…"
"The stores, obviously, didn't go so well and margins were under pressure but we think a lot of these are really temporary factors."
Flowers expects when stores can trade in a somewhat normal fashion, the company's margins will find balance between those of the first half of financial year 2022 and those of financial year 2021.
The pros of investing in Adairs stocks
Market watchers likely know Adairs as one of the key homeware stores in many shopping centres around Australia. But it's much more than that these days.
Flowers notes the company has recently set itself up to grow its profitability by landing some notable acquisitions.
The first was Mocka – a Brisbane and Christchurch-based kids-focused online-only furniture retailer.
In late financial year 2020, Adairs announced it was bringing the settlement of the acquisition forward to September 2021.
More recently, Adairs picked up Australian furniture retailer, Focus on Furniture for $80 million.
Flowers, who – alongside The Motley Fool team – has kept his eye on Adairs for a while, said the Focus on Furniture acquisition answered a long-standing question:
We didn't know what they were going to do with the cash balance – whether they were going to buy back shares, pay extra dividends, what not. So, [the Focus acquisition], we kind of took it as it comes and evaluated it when they made the deal.
It's buying a decent business, at a very attractive price. When you're buying these private market businesses, and they had a big cash balance, they're paying these low prices and they can expand and enhance the profitability over time.
He believes the acquisitions provide Adairs with strong cross-selling opportunities and the ability to expand the footprint of both Mocka and Focus on Furniture. The former into bricks-and-mortar storefronts and the latter into northern New South Wales and Queensland.
The other major factor Flowers likes about Adairs shares is its paid membership offering – Linen Lovers.
More than 950,000 Australians hold Linen Lovers membership. For context, the country's population is around 25.7 million.
"[Linen Lovers'] growth rate of the past several years has been about 14.5% annually," said Flowers. "It's a really strong growth… [and] growth in Linen Lovers members and sales growth [are] very highly correlated."
"[Members] spend more in store… they're more frequent shoppers and they account for about 80% of sales each year. I think the average Linen Lover member shops about four times a year."
Finally, Flowers likes the company's online and in-store sales channels. He said its omnichannel offering is "the best combination".
What are some risks of investing in Adairs?
There are three key risks Flowers believes investors should consider when looking at Adairs shares.
The first is the company's debt.
"Previously it had a net cash position," said Flowers. "But it's just paid for Focus on Furniture, and it paid the earnout for Mocka… and now it has a net debt position."
Additionally, as with most retailers, Adairs has a large amount of competition.
Its business is also dependent on consumers. Thus, changes in consumer spending could impact Adairs.
As Flowers note, there are a number of reasons consumer spending could change.
One example is if interest rates go up, some might spend more on their mortgages and forego retail purchases.
Another is simply consumer preference – some future consumers might want to spend their cash on an international holiday rather than at Adairs.
Are Adairs shares good value?
"If you want to take a good look at the business, now's the time," said Flowers.
While the company's official results for the first half of financial year 2022 aren't expected to drop until 21 February, the recent trading update has provided a small window into the company's valuations. Flowers commented:
If we look at the earnings before interest and tax (EBIT) they made in the first half of the year and we say they're going to make that in the second half and we put a 30% tax rate on it, we get about $45 million in net profit.
And if you look at the current market capitalisation – $565 million – it's a price-to-earnings (P/E) ratio of 12.5.
Additionally, he notes Adairs' sales have grown 10% annually since financial year 2017.
Meanwhile its earnings before interest and tax (EBIT) operating income has grown faster again.
The opinions expressed in this article were as at 9 February 2022 and may change over time.
