Nick Scali's fully-franked home comforts

Alan Kohler here with today’s CEO, and it’s Anthony Scali of Nick Scali furniture business, NCK is its code, and Anthony has been running the business for 15 years since he took over from his father Nick, of course. The company has been listed for 15 years.

I first interviewed, or last interviewed, Anthony two years ago in October 2017, and the share price at that point was $6.60, and today the share price is $6.60, so basically the same as when I first interviewed him two years ago, gone nowhere, and in the meantime the share price has gone down to below $5 in December last year and has recovered again. So, it has been a good recovery, if you were lucky enough to buy around $5 in November/December, it has been a good ride, but if you bought back two years ago, in terms of capital, it has been the same, but it has become a very good dividend payout.

He’s paying out 86 per cent of earnings per share in dividends and it’s currently yielding just under 7 per cent, fully-franked. That’s one of the best yields on the market. It probably won’t stay the same, that’s to say the dividend will probably be cut in the near-term.

Nick in the interview says they will keep the payout ratio around where it is, he says they have plenty of cash, and no problem maintaining the payout ratio around 85 per cent. But it is possible, he’s not sure, it is possible the earnings per share will come down a bit over the next 12 months or two years.

The problem is the business of selling furniture a bit, or largely tied to, the property cycle. The property cycle appears to have turned and is improving. Nick Scali as it stands is an income stock and a bit if a play on the property cycle, a bit of a play on the residential property cycle if that’s what you like to do. There’s not a lot of capital growth here, but it’s potentially a reasonably solid, high-yielding, fully-franked income stock. That’s the reason for listening to the interview with Anthony Scali, the CEO of Nick Scali.

Anthony, when you took over as MD and the company listed, it floated in 2004, the first dividend was one cent on earnings per share of 8.6 cents, I’m sure that’s branded in your memory, a payout ratio of just under 12 per cent.  In the latest 12 months it was a 45 cent dividend on earnings per share of 52 cents so a payout ratio of 86 cents.  Have you consciously focused on dividends and capital management because it’s obviously now quite a high yielding 100 per cent franked stock.  Is that something you have tried to achieve?

Yes.  One reason is we generate a lot of cash and as you can see on our balance sheet there’s a lot of cash.  We do have debt but the debt is against retail properties the company owns and they’re very conservatively geared.  That’s actually a benefit because we’re not paying rent, we’re just paying interest on the debt against those properties.  We own nine retail properties, debt of $33 million, so the occupancy costs are very low on those because the interest we pay on those properties is really low.

You’ve also got $36 million cash in the bank as well.

Correct.  We ignore the debt almost because the debt’s against property and it’s very well secured and rather than paying rent, so you’re right, we’ve got a lot of cash in the bank.  Hence, why not have a high payout ratio and reward shareholders for that.  We’re lucky our business model just generates cash, as long as we’re making money we’re generating cash.

Talk to us about your intention with the payout ratio, do you think you can maintain 85% possibly above that into the future?

Yeah, I think so, and even doing that probably still allows us to buy another retail store that we might want to own because we think long term that’s a good strategy to keep increasing the number of stores we own.  Providing the business performs we can continue with that.

That’s the juggle, isn’t it, between opening new stores and buying stores, and paying a dividend because all of your growth in recent times has come from new store openings not from same store sales.  You really have to open new stores, don’t you?

That’s right, but new stores don’t require a lot of capital expenditure, it’s really $300,000 of stock and another $300,000 fit out so it’s not a huge amount in capex.  Even with the high dividend payout ratio we can still open stores because there’s not a lot of capex that’s required.

You’re going to open, I think, four in the next twelve months, is that right?

Correct, and two of those are in New Zealand.

That’s right, so the aim is to get to 85 stores in Australia and New Zealand, how far short of that are you now?

We’re at 57 stores now so we have got a fair way to go and we’re very keen to accelerate New Zealand, we’re performing really well in New Zealand and still continuing to so we want to increase the store network there and that makes that a lot more profitable because you get economies of scale with the infrastructure that we have in place.

Let’s talk a bit about the market in Australia, obviously it’s been two years of property downturn, house prices falling, property market has been very soft.  Explain to us what that’s done to your sales and to what extent are you tied to the property cycle?

In the last year you can see from our result the same store sales was negative 1% and that is a result of the housing sales transactions falling and I think consumer confidence is lower and there’s a negative wealth effect on the consumer because they have seen their properties drop in value.  That’s been hurting the traffic in stores, it has dropped, so we’re focussing on trying to convert more people but it’s created a much tougher environment and hopefully property prices seem to be stabilising now.  We’ve got lower interest rates so we’re hoping people get a bit more confident and those that may have held off selling a home and upgrading or renovating will now make that decision to go and do it.

One of the standout things about your business is your profit margin, your gross margin is 63 per cent, it’s an unbelievable margin really and it increased in the latest 12 months so even though same store sales were the same roughly your margins are improving so why is that and how can it keep going?

The margin improved really not because we raised prices, it was more about in the furniture business it’s about the leakage on margin that counts.  You might get a first margin but your margin will be eroded if you make bad buying decisions and you have to lower prices to quit stock or you’re not managing your inventory well.  We have made a lot of improvements in managing our inventory and reduced the leakage on the margin which has improved.  It’s only a small improvement, it’s 20 basis points, but really it was all down to just better managing our inventory.

Yeah, that’s right, it was a very small improvement but still it’s better than being screwed.  The thing is it’s such a fragmented industry, it’s not as if you’ve got 40% market share or something.

That’s right.  We’re a direct importer so we’re not buying from wholesalers so we have cut out the middle margin so to speak, we don’t buy through agents, we buy direct from the factories, the family is still involved from the buying, we’ve got long relationships and I think we buy well.  There’s no in between costs, it’s straight from the factory to our warehouse door and straight to the customer.  We deserve a good margin because of that and the other thing is managing inventory well and not making too many buying mistakes that margin is higher than our peers.

To what extent is your business a fashion business and to what extent do you have to stay on your toes in buying?

You have to be on your toes all the time and we travel to international fares in other countries looking at what’s happening, then there’s the factory visits and even at our partner factories we see what’s happening in other places in the world so it’s not really a fast fashion change, furniture, but it’s changing.  It changes slowly, the trends start to emerge so you’ve got to be onto that.  Sometimes we’re a little bit early and then it happens a bit later.  You’ve got to be onto it.

The other thing that I was wondering about is the extent to which online sales are earing into your profits and are you selling online as well?

No, we don’t sell online because we have got engagement, we’ve worked very hard on our website and people today do a lot of research before they come into your store.  We have upped the engagement when people are visiting our website, we’re engaging with them, but really if you’re selling a lounge and it’s custom made, which 90% of our lounges are, we want people to go into the store, sit on the lounge, make sure the comfort is right for them and the colour they choose is correct.  Online that’s very difficult.

Will that continue to be the case for the foreseeable future?

I think so.  We’re watching it.  We look at other furniture retailers that sell lounges online and they’re really having problems.  There are a couple of big players in the UK, none of them make money and the reason is they get returns, the return rates are very high.  In furniture if the return rate is high you’re in trouble, it’s not easy to make money because that’s the margin leakage, it only amplifies it.  I think where we sit in the market, middle to higher middle, it’s difficult to sell online.

In that segment of the market that you’re in is there much competition and is there a potential for a sort of roll up strategy on your part?  You were talking about buying stores before, are you looking at buying competitors?

If an opportunity came and it was a reasonably sized business and it wasn’t in our space, wasn’t in the mid to upper-mid segment, we would look at an acquisition.

When you say not in your space which way would you go?  Up market or down market?

We can see ourselves really middle to upper middle, I’d be looking at something more middle to lower middle, not too far down the chain.

Why is that?

I don’t like it too low, I think they’re very difficult businesses when you get very low, to the low end.

You could also bugger up your margins I presume.

Correct, yeah, and it’s more about a stocking model than the customising model now whereas in the mid, even to lower mid, lounges can be sold customised which means you hold less inventory which makes it a much more efficient business. 

What’s your view of the future for your business, are you feeling optimistic now that the property market has turned?

I think it will turn providing we don’t end up in a recession.  I know interest rates are low, unemployment is stable, wage growth – there’s going to be tax cuts that offsets the problem with wage growth and I hope that works, I hope that is expansionary for the economy.  We’re really dependent on that.  The signs are that that should happen but then you’ve got all the global problems at the moment with the trade war, etcetera.  I’m optimistic, I’m just cautiously optimistic at the moment is probably the way to answer that.

Some of the brokers are saying that your earnings are going to come under more pressure in the future, do you think that’s possible or are you disagreeing with that?

In the short term that is possible, I think in the short term.  Long term, no, I think we’re just going to continue the strategy which is to expand the store network and open the stores particularly in New Zealand so we just stay focussed on that, in the short term we might come under pressure.

Do you think you will maintain the dividend where it is, is that the intention?

As a payout ratio, yes, in terms of the payout ratio.

I think we’ll leave it there, Nick, thanks very much.

Okay.

Sorry, Anthony, I beg your pardon, your father is Nick.

Yeah, that’s right.

Good on you, thanks very much.

Okay, Alan, thanks.  See you.

That was Anthony Scali, the CEO of Nick Scali.