QUALIPORT
Armchair Investing: DFS v ScS

By Maynard Paton (TMFMayn)
April 24, 2003

DFS Furniture (LSE: DFS), the country's leading upholstered furniture retailer, looks cheap. The Qualiport member today published a steady set of interim results and the shares responded by adding 9p (2.6%) to 357.5p. At present, investors are being offered a historic free cash flow yield of 8.5% and a dividend yield of 6.4%. Very nice.

(For readers wanting a refresher on DFS, background information can be found here, here, here and here.)

Results

Today's half-year figures are summarised below:

Six months to February 1st        2003       2002 

Turnover (£k)                  241,869    211,689
Operating Profit (£k)           25,896     25,712
Exceptional Items (£k)               -     17,422
Pre-tax profit (£k)             26,149     43,163

Earnings per share*(p)            16.8       16.4
Dividend per share (p)             7.0        6.7

(*before exceptional items)

First half turnover improved 14% to £242m. Underpinning the increase was a 3.5% improvement in like-for-like sales and four extra stores (taking the estate to 63). Though DFS made numerous references to 'international political and economic uncertainties', same-store sales have started the second half 3% ahead.

Operating profits improved just 0.7% to £25.9m. Additional expenses relating to a new distribution centre combined with pre-store opening costs largely restricted profit growth. 'Relentless upward pressure' on rental costs and extra customer service staff also hindered operating margins, which were 10.7% in the period.

The balance sheet remains strong. DFS carries no debt and, adjusted for money associated with the Primback Case, has £19.3m (18.2p per share) of cash in the bank. Assuming maintenance capital expenditure is twice the depreciation charge (read more), DFS produced 28.9p of free cash during the twelve months ending February 1st 2003. Accounting for the cash pile, at 357.5p, the shares offer a free cash flow yield of 8.5%.

In general, DFS published a stable but unspectacular set of results. The company also confirmed it was on track to meet its full-year targets. Admittedly, DFS does not possess the greatest of moats, though experienced management, economies of scale, an extensive product range and in-house manufacturing (associated with 15-20% of sales) do provide a competitive advantage of sorts. Operating margins have deteriorated steadily over the years and the company today noted an 'increasingly competitive market place'. Still, DFS remains a simple, focused business with exemplary accounts. An incremental return on equity of 69% and regular special dividends should count for something. Overall, DFS is a good business operating in what can be a difficult industry.

Sofa kings

As noted last week, ScS Upholstery (LSE: SUY) appears by far the most attractive of all the non-Qualiport home furnishing retailers. So how does this firm's finances stack up to those of DFS, its larger rival?

The latest full-year figures from DFS and ScS are shown below. Also included is the DFS performance of 1995 (the first year following the company's flotation), when DFS was of a similar-ish size to ScS now:

                                DFS 2002     DFS 1995      ScS 2002

Sales (£k)                       462,154      145,141        97,787
Operating profit (£k)             53,131       24,550         9,572
Lease costs (£k)                  15,043        2,611         5,944
Staff costs (£k)                  48,638       11,862        13,156

Average store number                57.5         29.5            44
Average staff employed             1,974          720           675
Average equity employed (£m)      44,083       20,252        12,382

Sales per square foot (£)            500   not disclosed        184
Sales per store (£k)               8,037        4,920         2,222
Sales per staff (£k)                 234          202           145
Sales per £1 equity (£)             10.5          7.2           7.9

Operating margin (%)                11.5         16.9           9.8
Lease costs/sales (%)                3.3          1.8           6.1
Staff costs/sales (%)               10.5          8.2          13.5

Though the comparison does not consider differing accounting practices and the timing of store openings, DFS looks to have the beating of ScS on a 2002 basis. Showing a greater operational efficiency, the Qualiport retailer generates more sales per square foot of retail space, more sales per staff member and more sales per £1 of shareholders' equity than its smaller rival.

Even after reporting the 10.7% figure in today's half-year figures, DFS's operating margin still beats that of ScS. Notably, DFS also pays relatively less in lease costs and staff wages. And DFS staff have greater salaries on average than their ScS counterparts (£24,600 versus £19,500), too. From this evaluation, DFS remains the sofa king.

The author owns shares in DFS Furniture.