Uncomfortable times for DFS as shares dive

Investors in UK retailers had a fright Thursday as they woke up to the worst set of retail sales figures for more than four years. Shares plunged across the board with Next, Dunelm and N Brown among the biggest casualties.

But spare a thought for DFS Furniture shareholders, whose process of settling into their settees, powering up their laptops and checking their portfolios would have been much more uncomfortable than usual Thursday.

The sofas-to-beds retailer was easily the worst performer on the FTSE All-Share after a profits warning wiped out more than a fifth of its value. The stock traded below 200p for the first time since last summer, and not far off its lowest level since listing two years ago of 176.50p, hit in the aftermath of the EU referendum.

The trading environment has "weakened beyond our expectations", DFS said, so cash profit for the full-year is now expected to be £82-87 million, giving pre-tax profit of £53 million. That's 17% below consensus expectations of £64 million.

UBS analyst Andrew Hughes now pencils in £55 million of profit in the year to July, giving earnings per share (EPS) of 20.3p, down from 23.5p a year ago. That puts DFS on less than 10 times forward earnings. Assuming, as UBS suspects, it does make 23.8p in 2018 (down from 25.3p previously), the shares would trade on 8.3 times earnings. Sounds inexpensive, assuming it steers clear of anymore trouble.

It's all a far cry from last August when the company boasted that results for the year ended 30 July 2016 would be at the top end of market expectations.

True, the firm had already warned at half-year results in March that it was gearing up for a softening of the market, but this is worse. The news also accompanied a report from the Office for National Statistics (ONS) warning that retail sales grew just 0.9% year-on-year in May, the weakest growth since April 2013.

DFS confirmed it had seen "significant declines in store footfall leading to a material reduction in customer orders". Rising prices in retail outlets, inflation on the rise and low wage growth have combined to create a perfect storm among consumers.

Investec's Victoria Clarke points to a 7% year-on-year fall in furniture and lighting sales as "providing a further pointer to households cutting back on big purchases" - clearly a huge disadvantage for DFS.

Nathan Sweeney, senior investment manager at Architas, claims this is "a worrying sign for the strength of the UK economy," and will have a marked impact on the next read on GDP.

Only a year ago, DFS was our Share of the Week after putting in record performance and a generous dividend in 2016. But, with inflation now biting hard, retailers are buckling up for a tough period, with DFS claiming the problems are "market-wide".

Still, analysts are unfazed, with UBS's Hughes believing DFS remains the clear market leader, has a flexible business model and generates cash. He does cut his price target, though, to 275p from 310p.

Thankfully, a forecast dividend of 11p per share appears not to be in danger, according to Stifel's Scott Ransley. That now puts the stock on a prospective yield of 5.5%, "with the prospect of additional payout once trading stabilises".

"We do like the company long term," Ransley adds, "given market share dominance and cash-generative characteristics."

He does expect further earnings downgrades in coming weeks, though, and points out that sales have historically been volatile around pre-election periods - and this has been one of the most uncertain election outcomes for some time. "This has been compounded by the later Easter and unfavourable weather patterns (for home retailing)."

Ransley currently has a 340p target price on the stock, based on a weighted average of Stifel's sum-of-the-parts valuation and a discounted cash flow valuation. While this is likely to be revised downwards, the inflationary headwind is expected to peak soon.

"There may be an extended period of uncertainty but, assuming the UK does not move into recession, we still think the longer-term investment case remains attractive," adds Hughes.

It's been a rocky road for the furniture specialist since it was brought back to the market by private equity owner Advent International at 255p in March 2015 - an initial pre-IPO valuation of £1 billion was halved.

And, after peaking at 350p later that year, performance has never been entirely convincing. It fell back again last November when Advent sold half its remaining stake at 240p and the rest in February at 228p. Currently at sub-200p, that's good timing.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.