Is DFS Furniture PLC A Better Retail Bet Than J Sainsbury plc & Marks and Spencer Group Plc?

The UK economy may be going from strength to strength, but the fortunes of retailers have been extremely mixed — indeed, quite polarised in many cases. For example, Next, WH Smith and Topps Tiles have been thriving, and posting stellar share price gains, while home-shopping group N Brown, the big supermarkets and Home Retail (owner of Argos and Homebase) have been struggling, and their shares have suffered.

J Sainsbury (LSE: SBRY) has been rather more resilient than rivals Tesco and Morrisons, and Marks & Spencer (LSE: MKS) has performed reasonably well. Sainsbury’s and M&S have both enjoyed the support of many small private investors for many years, but could stock market newcomer DFS Furniture (LSE: DFS) be a better retail bet?

DFS is the subject of much popular ridicule: will any of us live long enough to see the end of the DFS sale? Moreover, can investors really make money from a company that shoutily advertises sofas that were £999, slashed to £499, NOW 99p? — okay, so one of the numbers may be a bit out, but you get the general idea.

At any rate, I didn’t give DFS more than a passing glance when it joined the stock market four months ago. However, first impressions aren’t everything, and I was spurred into having a closer look at the business by today’s pre-close trading update for the company’s financial year ending 1 August.

DFS describes itself as “the clear market leading retailer of upholstered furniture in the United Kingdom”. Being a market leader is a good start. Also attractive is the company’s vertically integrated business model, giving it control over design, manufacturing, retailing and a well-established delivery and installation infrastructure.

DFS has some promising growth drivers in addition to its programme of core UK 3-5 new store openings a year: acquisitions of Sofa Workshop in 2013 and Dwell in 2014 have added more aspirational brands to DFS’s core offering; a roll-out of smaller format stores targeting urban areas and small market towns is being trialled; and a move into Continental Europe has begun with a first store opening in the Netherlands.

In its trading update today, DFS said sales for the year to date are up an impressive 7% on last year. This compares very favourably with 2.5% growth forecast for M&S and zero growth for Sainsbury’s.

And, despite my underwhelming first impressions and expectations of DFS, the company does actually make decent money. DFS reported an underlying operating profit margin of 8.3% within its half-year results in March. M&S’s margin is running at 7.4%, and Sainsbury’s at 3.3%.

DFS told us today that “with positive trends in UK disposable income and consumer confidence currently continuing”, management is confident for the year ahead, and in the company’s longer-term growth prospects.

Sainsbury’s — like the other big supermarkets — has suffered from changing shopping habits. Posh grocers, such as Waitrose are doing pretty well, while hard discounters, such as Aldi and Lidl, are flying. There’s no sign that shoppers are flocking back to Sainsbury’s as a result of the positive trends in UK disposable income mentioned by DFS. Indeed, Sainsbury’s reckons that “savvy shopping behaviour learned during the recession has driven a structural shift in the market”. Of course, Sainsbury’s will continue to have a place in the market, but growth prospects appear far more limited than for DFS.

M&S’s food offering continues to do well, benefitting, like Waitrose, from the growth at the posher end of the food chain. However, the company’s food success has been undermined by persistent poor performance from general merchandise. Earlier this year, it looked like M&S might have stopped the rot with a first quarter of like-for-like sales growth in general merchandise for four years. However, sales went back into decline in the latest quarter.

General merchandise boss John Dixon, who had previously done a great job as head of food, has stepped down. Current food supremo Steve Rowe has been handed the poisoned chalice. With M&S’s general merchandise business, I’m reminded of a quote from Warren Buffett: “when a manager with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact”. I fear general merchandise will be a continuing drag on M&S’s growth prospects.

Retail isn’t my favourite area of the market for investment, but DFS appears better placed than Sainsbury’s and M&S to make hay while the sun shines. Furthermore, DFS currently looks attractively valued on a forward price-to-earnings ratio of 12.1, compared with Sainsbury’s on 12.7 and M&S on 15.3.

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G A Chester has no position in any shares mentioned. The Motley Fool UK owns shares in Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.