Why Dunelm just spiked to two-year high

Up nearly 60% since December, this retailer is doing all the right things and pays a generous dividend.

What a 2019 it's been so far for the retail sector, with shares in Next (LSE:NXT) and Marks & Spencer (LSE:MKS) up by around a fifth and Dunelm taking its gains to a stunning 37% following interim results today.

The turnaround has much to do with the industry being over-sold amid retail panic in the second half of 2018, although in the specific case of homewares retailer Dunelm (LSE:DNLM), it has recouped those share price losses and gone on to compete with levels last seen in early 2017. In fact, the shares are up almost 60% since sliding to 483p in mid-December.

Dunelm was one of the first companies to ease the fears of investors in January when it reported that second quarter like-for-like sales had improved 5.7% in its stores and by 37.9% online. CEO Nick Wilkinson, who took the helm a year ago, highlighted a strong performance in the financial year to date, but inevitably sounded a note of caution on the UK economy.

Fast forward by a month to today's results and the message from Wilkinson hasn't changed, much to the relief of investors as the Brexit date draws closer. Pre-tax profits were up 16.7% to £70 million in the 26 weeks to December 29, with the company confident that it will meet City full-year forecasts as long as economic conditions do not collapse after March.

The company looks to be doing all the right things to influence its own fortunes, whether that's through an increased focus on the core Dunelm business, a stronger product offering or enhanced online service.  

Broker Peel Hunt agrees with that sentiment, having recently upgraded its recommendation to 'buy' and arguing that the core performance looked like an "upgrade waiting to happen". They have a price target of 800p, which is still some way short of Dunelm's 997p peak of three years ago.

Analyst John Stevenson added: "Dunelm has signalled a return to form with two strong quarters. Short term, we flag the opportunity for this outperformance to spread into H2."

Source: TradingView (*) Past performance is not a guide to future performance

Gross margin improved by 170 basis points in today's results, helped by improved sourcing, FX gains and better end of season stock management. The worst of the integration challenges that came with the Worldstores acquisition now appear to be behind it.

What separates Dunelm as an investment proposition from many others in the retail sector is that it still has much growth to play for in terms of online. Only 12% of total sales came from Dunelm.com in today's interim results. Wilkinson said: "We are fully aware that we are still playing catch up as a multichannel retailer, having grown up as a store-based retailer."

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A soft launch of a new technology platform is planned for the summer, with the intention of offering click & collect services as part of this roll-out. It has already shut both Kiddicare and Worldstore websites and transferred the best of the product lines to the Dunelm website. 

Wilkinson said: "This has enabled us to invest all our energy back into the Dunelm brand, with one supply chain and one web platform; in so doing, we have significantly tightened our operational and commercial grip on the business."

One of the other attractions of Dunelm is an attractive dividend yield in the region of 4%. After free cash flow jumped to £91.2 million from £27.8 million a year earlier,  today's interim pay-out was increased by 7.1% to 7.5p a share. Peel Hunt also thinks there's potential for a return of special dividends in the 2020 financial year.

A forward price/earnings (PE) ratio of 15 is not particularly cheap, but it is at least in line with another retail success story JD Sports Fashion (LSE:JD.).

Dunelm currently operates 171 stores, of which 169 are out-of-town superstores and two are located on high streets. It employs approximately 10,000 staff and sells around 30,000 product lines in store, increasing to around 60,000 online.

*Horizontal lines on charts represent levels of previous technical support and resistance. Trendlines are marked in red.