Dusk - Is it a Buffett worthy stock

By: Chris Batchelor

My last two blog posts have focused on stocks that meet the criteria for the screen developed by Stockopedia contributor Roland Head, as outlined in his recent article titled “Screening for Warren Buffett stocks: the ultimate strategy?”, Roland created a screen that he believes would closely mimic the approach Warren Buffett uses to choose stocks that are likely to be great compounders. When that screen is applied to the Australian and New Zealand market today, only 10 stocks make the cut. So far I have written about Universal Store Holdings (ASX:UNI) (read here) and NZE listed Mainfreight (NZE:MFT) (read here). Today I will take a look at candlestick maker Dusk (ASX:DSK).

Dusk is a retailer of candles and other home fragrance products. They design their own products and sell them through their network of stores as well as online. They are not sold through other stores or market places. Candles are their biggest product however 64% of sales come from other products with diffusers and scented consumable refills rapidly catching up to candles.

Dusk underwent an IPO in November 2020. The price soared from $2 to $4 in the first eight months but then began a steady decline. The driver of this initial growth was strong sales during the pandemic which resulted in four trading updates during their first six months as a listed company, each revealing a further improvement in results.

Revenue hit $149 million in 2021. It is anticipated that revenue will be $140 million in 2023, a decline of 6% from the peak, but still 40% higher than in 2020. The pandemic led to a trend where people were spending more money sprucing up their homes. Things have largely normalised now with travel and entertainment now back on the agenda, but Dusk have managed to lock in a large portion of the gains made during that unusual time.

They are continuing to grow their store network which numbered 141 as at December 2022. They opened nine stores in the first half of FY23 and are aiming for six more in the second half. Online sales accelerated during the pandemic to 8.3% of total sales but have now retracted to 5.6%.

Dusk is a profitable business. Profits grew very strongly until 2021. In 2022 they eased back a bit and the first half FY23 results revealed they have come under more pressure this year. Gross margins declined by 1% due to increased promotional intensity and unfavourable currency movements. General overheads, referred to as Cost of Doing Business (CODB) by retailers, rose 16% driven by new store openings, higher wages and inflation. This was distorted somewhat by lower than usual CODB in 1H FY22 when stores in NSW, VIC and QLD were closed for extended periods and staff stood down. Net profit for the half declined by 9.5% to $13.3m but that still represents a very healthy net profit margin of 15.5%.

The downturn in sales continued into the first seven weeks of 2023. The softening macro environment is creating uncertainty, with ‘outside store traffic’ noted to be 6% lower than the previous corresponding period. Don’t forget that the same period last year was when the Omnicron variant of Covid was ripping through the land, so that was a quieter than usual period itself.

The fact that Dusk have managed to maintain strong profit margins despite the cost pressures contributes to their excellent Quality score of 91. The returns on equity and capital are very high and they are being achieved without the use of leverage. The Health Trend, Bankruptcy risk and Earnings Manipulation Risk are all in the green zones.

Like most retailers, Dusk receives cash at the point of sales, so sales and profits translate directly into strong cash flow.

They also have a very healthy balance sheet and at the end of December they had cash of $32 million and no bank debt.

In the short term, the current macro environment may see pressure on sales and margins. However we have seen whilst revenue and profits have declined from the bumper levels witnessed during the pandemic, they are still very healthy. Looking to the long term we can try and assess a company’s likely sustainable growth. To do this we focus on retained earnings and a company’s ability to fund long-term growth from retained earnings. Such a business is more likely to have a competitive advantage.

Stockopedia has an Expected Return metric which is calculated by looking at the company's 10 year average ROE and its typical dividend payout ratio. It is then possible to calculate an expected sustainable growth rate, based on retained earnings. Roland Head set a minimum threshold of 6% for this metric in his screen. Dusk’s expected return is 19.8%.

Dusks funds its growth from retained earnings rather than using debt or raising additional equity capital. Shares on issue have remained constant for the last six years and that includes their IPO where existing shareholders sold down their stake but new capital was not raised. The company now has a broad base of shareholders with no one shareholder having more than 5% of the stock.

CEO Peter King, has steered the ship since 2014. He has announced his intention to step down in August 2023 and the process to find a replacement is underway.

In addition to the high quality score, Dusk represents a strong value opportunity. The forecast PE ratio is only 7.2 and the forecast dividend yield is 9.4%, fully franked. The other value metrics are also strong including Price to Free Cash flow and EV to EBITDA.

The overall StockRank is pulled down by the Momentum Rank which is clearly suffering from the declining earnings and falling share price resulting in the price trading near 52 week lows.

Dusk is currently classed as a Contrarian stock. This means that an investor needs to be mindful of the near term headwinds, but for those who see a bright future on the other side of those then dusk may represent a sweet smelling value opportunity.

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