Interactive Investor

Dunelm triggers yet another round of profit upgrades

After finally making a break above £10 stick in December, the shares are unstoppable. Here’s why.

12th February 2020 12:29

Graeme Evans from interactive investor

After finally making a break above £10 stick in December, the shares are unstoppable. Here’s why.  

Dunelm (LSE:DNLM) continues to be the talk of the FTSE 250 index after more stunning trading figures today helped propel the homewares chain's record share price up by another 12%.

The mid-morning peak of 1,351p valued Dunelm at £2.7 billion, some 60% higher than in early December and not too far behind retail veteran and fellow second-tier stock Marks & Spencer (LSE:MKS) at £3.5 billion. That's quite a feat for a business that only started in 1979 selling second-hand M&S curtains from a market stall in Leicester.

The performance has left many investors scratching their heads wondering where this turbocharged growth has come from, and whether it's time to cash in. There will also be plenty of regrets for those who may have been put off jumping abroad by the endless pessimism surrounding the UK retail sector.

Source: TradingView Past performance is not a guide to future performance

A string of profit upgrades from Dunelm, including in December and again today in its interim results, highlight that there are still retail stocks with compelling investment stories.

In Dunelm's case, it is benefiting from various growth opportunities stemming from its recent migration to a new web platform. The switchover took place without a hitch in October, allowing it to host many more customers over the Christmas peak than was previously possible, while also introducing the option of click and collect services in its 170-store estate.

Analysts expect the new capabilities will allow Dunelm to accelerate spend per customer and further stimulate customer numbers. That's being supported by an improving product offer and greater brand awareness following sponsorship of ITV's This Morning.

CEO Nick Wilkinson insists there's plenty more for the chain to aim for, having reported a strong start to the third quarter on top of a 21.4% rise in earnings per share to 27.6p for the six months to December 28. Full-year profits are now expected to be slightly stronger than the top of the City's profit forecasts, which previously ranged from £135 million to £137.3 million.

That guidance has left analysts struggling to keep up with events, with Peel Hunt moving to 1,325p this morning from the 1,250p seen at the start of January, when it named Dunelm among 35 growth stocks to watch in 2020. Based on last night's price and consensus forecasts, Dunelm was trading on 21.3x 2020 earnings, higher than its long-term average and versus 16.2x for the rest of the retail sector.

The recent performance also offers the potential for further special dividends, having made a one-off award worth £64.6 million in October. Free cash flow was strong in the half year at £64.4 million, despite £20 million additional corporate tax, as the company lifted its interim dividend by 6.7% to 8p a share.

Analysts at UBS said there were “clear drivers” for growth in the second half of the year, despite Dunelm coming up against tough comparisons with last year's 15% growth.

The bank forecasts a 2.4% same-store sales improvement, which it thinks will be underpinned by four factors. One of the most significant is the market share gains that Dunelm should be able to achieve as mid-market department stores reduce their space.

UBS also sees the benefits of effective marketing campaigns and recent introduction of in-store tablets, as well as further multi-channel sales improvements following the platform upgrade.

They added:

“Evidence from Next shows when it implemented similar upgrades to its website in 2016/17 Directory growth accelerated to 12% in 2018/19, from 4% in 2017.”

UBS added £5 million to its Dunelm profits forecast for 2020, which it said assumed no significant disruption from coronavirus. The bank, which has a 1,110p target price, noted that about 17% of Dunelm's supplies were sourced directly from China, with a larger proportion indirectly via UK suppliers.

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