Dunelm (DNLM) – Time to Say Goodbye?

With a recent trading update released by Dunelm (DNLM) on January 12th, I wanted to take the opportunity to review a company making up part of my portfolio.  The update itself was decent enough, if not stellar, which begs the question: Does Dunelm still deserve a place in the portfolio?

Dunelm

Dunelm Trading Statement

                              13 weeks to 31(st)                  26 weeks to 31(st) 
                                 December 2016                       December 2016 
--------------------  ----------------------------------  ---------------------------------- 
                        Sales    YoY Growth   YoY Growth    Sales    YoY Growth   YoY Growth 
                        (GBPm)     (GBPm)         (%)       (GBPm)     (GBPm)         (%) 
--------------------  --------  -----------  -----------  --------  -----------  ----------- 
                                                 -1.4 
 LFL stores             215.6       -3.0           %        389.4      -12.5        -3.1% 
--------------------  --------  -----------  -----------  --------  -----------  ----------- 
 Home Delivery          20.1        +3.5        +21.7%      33.7        +5.6        +20.1% 
--------------------  --------  -----------  -----------  --------  -----------  ----------- 
 Total LFL              235.7       +0.5        +0.2%       423.1       -6.9        -1.6% 
--------------------  --------  -----------  -----------  --------  -----------  ----------- 
 Non-LFL stores         18.1        +7.5        +70.6%      29.3       +11.2        +61.4% 
--------------------  --------  -----------  -----------  --------  -----------  ----------- 
 Total Dunelm 
  excl. Worldstores     253.8       +8.0        +3.3%       452.4       +4.3        +1.0% 
--------------------  --------  -----------  -----------  --------  -----------  ----------- 
 Worldstores*            8.1        +8.1          -          8.1        +8.1          - 
--------------------  --------  -----------  -----------  --------  -----------  ----------- 
 Total Dunelm 
  Group                 261.9      +16.1        +6.6%       460.5      +12.4        +2.8%

All told, total revenue increased 6.6%.  Total year on year growth for the 26 weeks to 31st December 2016 increased 2.8%.  This however masks the decline in YoY growth from the core business by -1.6%.

Chart

Dunelm
Source: Google Finance

Dunelm has been stuck in a range for nearly four years, having also lost over 20% of its value during the past twelve months.  How has the company fared during this time?

The Numbers

Dunelm currently sits on a P/E of 14, Price to Sales of 1.6, Price to Book of 13, Price to Cash Flow of 11.6 and dividend yield of 3.7%.  Its debt to equity ratio is 0.9, higher than I’d like but nowhere near danger territory.

For the past ten years Dunelm has seen growth every year in revenue, net income and EPS.  They have raised the dividend 9 of the past 10 years, holding it steady in the other.

During this time they have maintained consistent gross margins between 45% and 50%, having increased during most of these years.  Operating margins have grown from just over 11% to nearly 15%.  Net income yield was 11.5%, having grown from 7% a decade earlier.

They have also maintained returns on equity and invested capital consistently above 30% for the decade, generating increasing levels of free cash flow.  All told, a very well run company who make efficient use of capital.

Intrinsic Value

As you may know, for companies with strong free cash flow I like to do a discounted cash flow to attempt to arrive at an intrinsic value for each company.  There are always assumptions to this system, therefore any figures should be taken as approximate.

  • Free cash flow has remained consistently high, having grown most years.  I have conservatively used a ten year average FCF of £51m (against the most recent FCF of £87m)
  • As mentioned, net income has grown in each of the last ten years, at an average rate of 14%.  In the past five years this growth has slowed to just under 9%.  Free cash flow grew at around 16% for these ten years, slowing to 13% for the past four years, therefore I have used a free cash flow growth figure of 10% for the subsequent ten years.
  • Following these ten years I have assumed growth slows even further to 3%.

At a current valuation of £6.74 this calculation yields a potential intrinsic value of £6.27.  A discount to the current price of approximately 7.5%.

Conclusion

My position in Dunelm currently stands at -26%, with a proportion of this fall having occurred in the days following the recent trading update.  I want to like this company.  Operationally and financially they are very well run, however this simply isn’t being reflected in the price.  I selected Dunelm before I seriously began looking at discount cash flow valuation, and in hindsight I would not have purchased based on the DCF calculation.  As you can see, it prices the company at a lower price than currently stands.

I have been in two minds as to what to do with Dunelm for some time.  On the one hand, they are an excellent company who have successfully grown their position in recent years.  I do however believe the price has run away from the company’s true value, perhaps explaining why it hasn’t really gone anywhere since 2013.  Were I to hold for the very long term, I believe this could be a useful stock.  However, in the short term I see little chance of the price improving to any extent.  The deciding factor for me will be whether I can identify a position more likely to improve my returns.

The game, as they say, is on.

Happy investing!

 

Disclosure: Dunelm is a constituent of the portfolio.

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