Selling Adairs Ltd (ASX:ADH)

I decided to sell Adairs because I previously missed the information in the latest update that suggests the underlying business generated weak cash flow during H1 22. In the latest update we are told net debt is $90.9 million. This compares to net cash off $26 million as at June 2021 and so there was a negative swing in cash of $117m.

There was a $17 million final dividend paid during the period plus acquisition payments totalling $107 million which totals $124 million. That leaves a positive $7 million cash move in comparison to the company's guided underling EBIT of $32 to $33 million.

In order to properly reconcile back to underlying EBIT we need to consider the higher seasonal tax charge in H1, acquisition costs, other one-off costs and interest charges but it still seems like a weak result to me (in H1 20 the company generated $17 million free cash flow on $23 million underlying EBIT).  Perhaps we will see a large build in working capital as a result of running the new distribution centre in parallel with the old one and that this will reverse in future periods. I don't know.

We are in an inflationary environment and I do not know how long it will last. Discretionary retailers are particularly vulnerable to inflation because they have limited pricing power and high input costs. Effective cost management is essential and I am not confident that Adairs is up to the task given this result.

On top of inflationary headwinds, it is likely we will see a swing back towards consumers spending more on services and less on goods as we emerge from the pandemic. Homewares was one of the biggest beneficiaries of consumer spending going into lockdown and so it is likely to be one of the biggest losers when exiting.

All in all there is too much uncertainty here for me to be sure that Adairs is as cheap as it appears based on headline consensus forecasts. Therefore, I sold my shares this morning.

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