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Here’s exactly what I’d do about Dunelm shares right now, and why 

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Just over three years ago I thought homewares retailer Dunelm (LSE: DNLM) looked like a good-value share. Back then, falling sales and negative investor sentiment had pushed the valuation down. The forward-looking earnings multiple was as low as 12 and the dividend yield ran above 4%.

Dunelm shares looked cheap

But there was evidence back in July 2017 that a long run of declining store sales had been broken with a modest quarterly increase. On top of that, Dunelm was making good progress driving internet-based sales. I said back then: E-sales looks like an emerging growth business cradled within the stable, cash-generating bosom of the old business.”

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To me, the fair valuation married with the potential growth from online sales and I thought the business could thrive to “potentially serve investors well from here”. And it did. Overall revenue, earnings, margins and operating cash flow have all marched higher over the three years since. Although there has been a down-blip due to the pandemic.

And shareholders have benefitted well from the recovery and growth in trade. In the summer of three years ago, the share price stood near 632p. Today, after a mighty surge up from the coronavirus low, the stock changes hands for around 1,426p. And that’s just above the pre-coronavirus high set in February.

Dunelm’s business has been trading and growing nicely, and the stock has advanced, as hoped. But now we have a problem: the valuation has moved from ‘fair’ to ‘stretched’. Indeed, the forward-looking earnings multiple for the current trading year to June 2021 is just above 28. And the anticipated dividend yield is as low as 2.3%. Both those measures are far removed from the attractive numbers of three years ago.

The dividend is toast, but current trading is strong

Meanwhile, the directors announced in today’s full-year results report that they’ve cancelled the full-year dividend. Indeed, Covid-19 has affected the business and both sales and earnings were lower in the period. The move to axe the dividend is part of a “prudent financial approach” aimed at retaining maximum financial liquidity ahead of winter peak trading. The outlook is “highly uncertain” the company said.

However, the directors expect the next interim dividend will go through as normal assuming no further material impact from Covid-19”.  Indeed, there are some big positives in today’s report. For example, online home delivery sales grew by almost 106% in the fourth quarter. And “strong” recent trading has delivered year-on-year sales growth of 59% in July and 24% in August. The directors put this down to pent-up demand and the timing of the company’s summer sale in a resilient homewares market.

Indeed, for the first two months of the current trading year, store footfall has been “positive” and digital sales were 31% of total sales. Online home delivery sales shot up by around 130% compared to the prior year, which I reckon reflects changing consumer habits in the coronavirus crisis.

Dunelm is trading and adapting well in a resilient sector. And the underlying growth story remains intact. However, investor support has been enthusiastic and I reckon the share price is well up with events. If I’d been holding Dunelm shares for the past three years I’d take some profits now. And I’d watch from the sidelines rather than entering a new position in the shares.

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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