If you are looking for evidence that a high quality business can do well over time, you need look no further than Nick Scali (ASX: NCK). Between FY06 and FY13, an investment in Nick Scali has yielded a compound return of 11.6% per annum (without reinvestment of dividends). This return may not sound high, note that our investment horizon covered one of the most difficult economic period since the Great Depression.
Nick Scali is a retailer of high end furniture with currently 40 stores in its network across Australia. The firm operates from its primary brand; Nick Scali, but also from its lower cost option; Sofas2go. Nick Scali also holds a license to distribute Chateau d’Ax, a premium Italian furniture brand.
The firm has been successful in keeping up to date with market demand for various styles and fashion. This is a critical element for success as it the grants the firm some pricing power and the ability to earn high returns over time. Table 1 shows the performance of Nick Scali in terms of return on equity and gross margins from FY06 to FY13.
Whilst its market share is low (less than 1%) the firm caters to a profitable niche of more affluent customers. Profitability over time is sensitive to consumer sentiment and this theory is supported by the firm’s financial results which I have compiled below in Table 2.
Evident in this table is the historically positive relationship between net income per store and consumer confidence. Note that the annual confidence index is calculated by taking the average of monthly consumer confidence indexes as produced by Westpac and the Melbourne Institute.
Over the long term, given the firm’s growing brand name and store network I expect to see strong results from Nick Scali. In the short term I would note that consumer confidence has averaged 99 over the five months to May 2014. Nick Scali had a strong first half NPAT result of $7.9 million which was up 22% on that of 1H13, however this was delivered when the 6 month consumer confidence average was 106. Given this, it would be wise for investors to be careful in their extrapolations of the full year result.