Dunelm’s new master plan fails to win over City

Dunelm Group (LSE:DNLM) has announced an ambitious three-year strategic growth plan which aims to capitalise on the group’s obvious underlying strengths.

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As such, the annual results themselves have taken something of a back seat and in any event were largely trailed within the full-year update in July. The group confirmed that sales rose by 3.1% in the 52 weeks ended 27 June to £1.83 billion, with pre-tax profit flat at £211 million. Despite its reputation as a value offering on home furnishings, the profit margin revealed a healthy level of 52.5%, although promotional events elsewhere have proved a small headwind.

Other key metrics also moved in the right direction, with free cash flow increasing to £154.8 million from £127.4 million and net debt reducing from £102 million to £94.6 million. Dunelm’s digital penetration also increased, with online now accounting for 42% of overall sales.

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Costs rose by 3.9% to £734 million, including but not limited to increased marketing spend on digital and higher incremental wage-related costs. However, the group’s general financial health enabled another increase to the dividend, where a yield of 5.1% is turbocharged to 7.9% including specials, which is a clear investment attraction of the stock.

The group has noted that the first six weeks of the new year saw softer trading as shoppers were less willing to battle against the hot weather, although the trend has more recently improved. In terms of outlook, 3% inflation and further capital expenditure of between £60 and £70 million this year is likely to result in adjusted pre-tax profit remaining much the same as for this year.

Nonetheless it is the strategic update which has garnered most investor interest, though unfortunately in a negative manner. Over the next three years, Dunelm is to launch its “Winning Hearts & Homes” initiative, which at its core aims for mid to high single-digit growth driven by increased customer loyalty and spend. At the same time, the group is planning to remove £100 million of unproductive costs by 2029, while using its cash generation to continue to invest in the business.

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A £30-40 million spend on infrastructure over the next two years will be accompanied by additional capital expenditure of £125 million on store expansion and renewal, with around 10 new openings per year expected over the term as well as the optimisation and refurbishment of more than 50 stores in the next two years.

In all, the aim is for pre-tax profit margins of around 11% and a Return of Capital Employed of approximately 30%, with the strategy being very much customer centric. The group has clearly undertaken detailed research on not only its own customer habits, but of those overall within the estimated UK addressable market of £25 billion for homewares and furniture. Dunelm recognises, however, that it still only captures a small proportion of that opportunity and as such, the new strategic push is not only necessary but perhaps overdue.

Of course, this reset comes at a difficult time, with the propensity of consumers under their own budgetary pressures and with rivals continuing to sharpen their offerings in what is a highly competitive space. The challenge therefore will be for Dunelm to consolidate the store offering to which it is clearly committed, alongside a revamped digital offering which reflects the tendency of customers to prefer an omnichannel experience.

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There is certainly much work to be done to arrest the slide of the shares over recent times. Despite a 16% bounce in the price over the last three months, the previous profit warnings over the reporting period have very much left their mark. In the last year, the shares have declined by 28%, as compared to a gain of 13% for the wider FTSE250 and the reaction to the strategic update is clearly one which reflects an underwhelming response that the new push simply does not go far enough.

Such investor disappointment may also weigh on the market consensus, previously coming in as a strong buy due to no immediate valuation concerns and attractive shareholder returns. But that may now be subject to downgrades on a growth plan which has failed to capture the imagination of investors by a wide margin.