Nick Scali Limited (Nick Scali, the Group, ASX: NCK) was established 60 years ago by Nick D Scali and listed on the ASX in May 2004. Its shares traded at $1.21 on the day of listing, up from the $1 issue price. Today the Group is one of Australia’s largest importers of quality furniture, with 128 stores and showrooms across Australia, New Zealand and the UK.
Freight delays and costs impacting earnings
Nick Scali has announced that one of its freight forwarders is now under Administration. This has resulted in a significant number of the Group’s shipping containers being delayed at ports. Consequently, the delivery of products to warehouses for distribution to customers is being delayed and additional storage and detention costs are being incurred. These additional costs cannot be quantified by the Group at this time and management have stated they add significant risk to the Group’s ability to achieve its prior earnings guidance of $30 to $33 million for the current half-year.
The risk to earnings guidance arises because in recognising revenue in relation to the sale of goods to customers, the key performance obligation of the Group is the delivery of the goods to the customer, and revenue can only be recognised at the time of delivery of the goods to the customer. In other words, delays in the delivery of goods late in the half-year directly lead to delays in revenue recognition for the December half.
Compounding the problem caused by the shipping delays is that in October the Group warned that materially higher unexpected freight rates are impacting the Group’s gross profit margin, particularly in the second quarter. Fortunately, this decline in gross profit margin was factored into the $30 to $33 million first half-year profit guidance estimate.
What’s next?
Once the inventory sitting in transit can be moved, the financial impact of the freight delays can be quantified, and updated earnings guidance will be provided by the Board.
On a positive note, the impact of delays in the delivery of product for which written sales orders exist is temporary, because once delivery has occurred the corresponding revenue can be recognised. This timing difference may distort the half-year on half-year revenue comparison, but the key point is that the revenue is not lost to the Group.
At the time of writing, the Nick Scali share price is down about 1.8 percent, compared to the S&P Consumer Discretionary Index (XDJ) which is down 1.1 percent.
The key question for discerning investors is that while the Nick Scali share price has declined following the announcement of the freight delays, has the share value changed? The simple answer is no, because the underlying intrinsic value of the Nick Scali business hasn’t changed. The earnings potential, brand recognition, customer and supplier lists, internal operating systems and other intellectual property remain intact.
Nick Scali’s future earnings prospects remain positive, and the current share price weakness may represent a buying opportunity for astute investors.
