It has been a fairly introspective week for me. As I have mentioned on Twitter, I’ve begun giving serious thought to some of the positions in my portfolio. A flurry of results released in the past fortnight have given some indication as to the short-to-medium term direction of a number of these companies, with updates from Dunelm, Wizz Air, Michael Kors, Gilead Sciences and Diploma.
Whilst I am still most definitely an amateur with regard to the investing business, one good thing going for me is that I do not act rashly. True enough, I am almost sloth-like in my investment activity, believing it is better to assess a situation before taking action. I therefore want to take another glance at Dunelm (DNLM) as this is the one position causing me the most cause for concern.
Dunelm – An Introspective
I wrote a few weeks ago about Dunelm (see here) following their trading update in January. With their half-year results released last week giving further detail into the direction of the company, it seemed appropriate to take another look. I wrote at the time, and still believe, Dunelm to be a quality company. A quick look on the Key Ratios page for Dunelm on Morningstar suggests a company able to deliver steady growth in revenues, net income and free cash, with consistent margins and impressive returns on equity, assets and invested capital.
I also wrote, however, that a discounted cash flow model implied that the share price was a little overcooked (it has since narrowed almost in parity with my calculation). Had I been using my DCF model when I first bought Dunelm, I likely wouldn’t have made the purchase at the prevailing price.
Reading through their interim results presentation, management clearly identify that the company is in a transitional period. A decline in like-for-like sales has been partly put down to “fewer winter sale days falling in the accounting period” (credit: Investors Chronicle). The IC also note that “underlying sales growth would have been about 0.9 per cent” had this not been the case. The November acquisition of Worldstores has also impacted upon the company, with an added exceptional operating costs of £9.3m.
Reading through the half-year report it is clear to see management have identified and are seeking to improve upon a number of areas of the business. I appreciate the transparency in detailing the initial issues with the acquisition of Worldstores, as well as disruption to the supply chain, leading to increased costs in the short-term. They have identified, and are making progress on, three key areas of the business: Increased LfL sales growth, rolling out new stores, and growing their online offering. A 20.1% growth in online home delivery sales clearly shows the latter is heading in the right direction, and has certainly helped mitigate the decline in store sales. Alongside the online offering, improvements to the in-store business look to be improving too. Latest openings “traded better than forecast” and the roll-out of new stores is continuing as planned.
My rationale has always been to buy quality companies. You won’t see me taking a chance on a small mining or oil exploration company. Dunelm certainly fits the model of a quality company, but the question for me comes down to price. I currently sit on a theoretical loss of -31% in this position, however it has been pointed out to me by multiple people (not that I should have needed it) that by viewing the position in this way I am “anchoring”, and they are absolutely right.
Taking a step back, I see a few options available to me:
- Close the position – Do I admit I paid too much for Dunelm and close the position? Are their days of growth over?
- Keep the position open – Do I trust the company to overcome short-term issues and continue their history of growth and capital return?
- Take a larger position in the company – Do I recognise that the company may now be more attractively valued and buy more?
At this point in time I have decided to continue holding Dunelm in my portfolio. I recognise the potential for the share price to fall further, which if it does to any great degree may make me think about buying more. I am reluctant to do so at the moment as management clearly identify the company as being in one of a slightly uncertain and unstable future in the short to medium term.
I am reluctant to sell, not because I fear crystallising a loss, but because my plan has always been to buy quality companies and hold them for the long term. With all that is going on, Dunelm have still managed to raise the dividend, and I recognise the fact that they have also issued special dividends in six of the past ten years.
I will await their full year results in September, at which point we will see whether things are still moving in the right direction.
Disclosure: DNLM is a constituent of the portfolio.
If you’d like to discuss anything contained in this article, contact me on Twitter @britishinvestor.