Dunelm Group PLC
LSE:DNLM
Earnings Call Analysis
Q4-2023 Analysis
Dunelm Group PLC
Dunelm's financial year ending on July 1st showcased a story of resilience and strategic agility. Despite the significant headwinds of widespread inflation affecting customers and businesses alike, Dunelm managed to deliver a stellar performance. Sales growth climbed 6%, bolstered by both physical stores and digital channels, and market share alongside customer numbers saw an uptick, a testament to the company's compelling value proposition and its ability to cater to evolving consumer needs.
Profit before tax hit GBP 193 million, slightly surpassing market predictions while demonstrating strong control over operational efficiencies. Free cash flow generated was noteworthy at GBP 160 million with an impressive conversion rate of 81%. Notably, the year concluded with a modest net debt of GBP 31 million. In recognition of the strong financial metrics, the Board is proposing a final ordinary dividend of 27p per share, culminating in a total ordinary dividend of 42p per share for the year, marking a 5% increase year-on-year.
Dunelm experienced widespread sales growth, with digital sales claiming a 36% share, hinting at the company's astute response to the digital revolution. Moreover, the company didn't shy away from innovation, expanding its product offerings by 20,000 new lines online. Market share in the homewares and furniture market swelled by 40 basis points to 7.2%, a clear indication of Dunelm's expanding influence, especially notable among 16- to 24-year-old consumers and those from lower-income groups.
Gross margin remained robust at 50.1%, aligning with guidance despite a predictable 110 basis points dip from the prior year due to pre-COVID sale patterns and rising input costs. Dunelm exercised acute operational discipline to combat inflationary pressures, enabling continued investment in business growth. Looking ahead, the company has hedging and contracting policies, allowing for increased visibility into FY '24's input costs with anticipation of a 100 basis points gross margin improvement.
Dunelm is setting its sights high, with investments in technology and digital capabilities, totaling GBP 22 million, to enhance customer experiences and operational efficiency. This is part of a broader vision to evolve the company's total retail system sustainably, with the Board prepared for an uptick in the operating cost to sales ratio to approximately 39% in FY '24, reflecting an unwavering commitment to growth even amidst expected continued wage inflation.
Dunelm is well-positioned within a homewares market that has demonstrated robustness against cost-of-living pressures, with the company being a low-ticket retailer, which bodes well for sustained consumer spending. This resilience, coupled with the company's multi-channel retail strategy and the creation of emotional connections with customers, lays the groundwork for continuing to seize market opportunities and deliver joy to its customers.
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Good morning, and welcome to the Dunelm prelims presentation covering our financial year ending the 1st of July. My name is Nick Wilkinson, and Karen Witts and I are delighted to welcome you to the office of Peel Hunt in London and to all of those who are joining virtually. Whether you're here in person or virtual, I hope you're well and feel connected to us in the continuing story of Dunelm. At heart, we are a product and a people company. To understand us, you have to understand our product. This picture is from one of our current season styles called Pride and Joy. And you have to understand our people. Some of them are here today, Alison Brittain, many members of our Board and some of the exec team, too. But of course, most of my colleagues are working on the finding stores and in distribution or engineering and creating our products, digital channels and content. Karen and I will do our best to bring all this to life for you today, aided by a short video. And yes, there is some joy in our numbers. If you're familiar with these presentations, we'll keep the normal running order, a short overview from me, then Carl will go through the FY '23 results and guidance for the year we've just started, and I'll be back to update on our plans before we take your questions. So onwards. Strong performance in the year. The environment was, of course, a challenging one with high levels of general inflation, bringing uncertainty to our colleagues and customers as well as to businesses. We focused on executing successfully on the levers within our control. Sales growth was at 6%, up in both stores and digital, and we grew market share and customer numbers, raising the bar on our customer offer, especially in terms of relevance and value for money. PBT performance in a more normal year than the previous one was good at GBP 193 million, which reflected strong operational grip on gross margins and costs. And we've continued to invest for future growth. Free cash flow grew in the year at GBP 160 million, and we've announced the dividend today to bring our total ordinary in the year to 42p per share. We strive to make good decisions, balancing the needs and expectations of our key stakeholders and ensuring what we do is sustainable. Doing the right thing for the long term is in our DNA from our founders. Rather than go through each of these in turn, I will highlight some of the key achievements with regard to delivering sustainably for our colleagues and on the work we're doing with our suppliers on reducing our impact on the planet. As I've said, our colleagues are at the heart of our business. The current economic environment has been difficult for many of them. And during the year, we increased our support on financial well-being. We introduced progressive pay increases, meaning higher rates of increase for lower paid colleagues and additional support funds and help on a range of financial matters. We're also investing in learning and development to help colleagues to grow their careers with us, including in those areas where roles are changing because of technology. One of the advantages of this approach has been improved colleague retention, increasing by 5 percentage points to 87% in the last 12 months, itself a driver of improved productivity. With suppliers, we have always built long-term relationships, offering them strong partnerships based on mutual growth and respect. Together with them, we are building shared knowledge on topics like circular product design and more sustainable materials and manufacturing. We extend our conscious choice label, which is applied to products that are made for more sustainable materials to 15% of our own brand range. Also working with suppliers, we've reduced our virgin plastic packaging by 1/3 since FY '20. There's a lot more to do. I'm delighted to say that our targets and basement have now been approved by SBTI, the science-based targets initiative. And I'm pleased with how much we are learning and how engaged our buyers and suppliers are on these important matters. With good long-term decisions, we're able to grow sales sustainably and seize the opportunity for future growth. FY '23 was a different year of growth in some ways. It was below our long-term post-IPO average growth rate of 10% and slightly more of that growth coming from market share gains with our markets broadly flat overall in the last 12 months. As the year progressed, sales growth was increasingly driven by volume. We said in our Q4 update that volume came through particularly strongly as the driver of sales in the last 13 weeks of the year. And I can share that the same is true for the first 10 weeks of this year. We are a volume retailer, and we like to see our sales growth driven by volume. With robust sales growth and good margin control, we have not hesitated to continue to invest for growth, choosing to maintain the momentum we've been putting into capability building in data and insight, engineering, performance marketing and product development over recent years. As a result, as we look at our highly fragmented market, we see enormous opportunity. There's never been a better time to be a well-resourced and ambitious market leader. So I'll tell you more about our plans for future later. And I'll hand over to Karen.
Thank you, Nick. Good morning, everyone. It's great to see you here and also those of you who are joining remotely. So let me start with a headline financial summary of the 52 weeks to the 1st of July 2023. I'll go into more detail as we go through the presentation. You will remember that last year was one of those 53-week years. So you will see last year's statutory figures as a memo, and I'll talk to performance versus the comparative 52-week period. As Nick said, we were pleased with our performance in what was a challenging year of inflation and cost management for us and ongoing cost of living pressure for our customers. Despite this backdrop, through maintaining our focus on choice, relevance and value, we achieved record sales of GBP 1.64 billion, a 5.5% increase on the prior year, which you might remember, included an extra sale period in the first quarter. Our gross margin of 50.1% was in line with our guidance and as expected, 110 basis points lower than the prior year. We applied our usual operational grip to create efficiency savings to help offset inflationary pressures in our operating cost base, particularly coming from labor inflation. And even against this backdrop, we continue to invest in growing and digitalizing the business. Our profit before tax of GBP 193 million was slightly ahead of market expectations and GBP 16 million down year-on-year as expected. We're pleased with this performance in a challenging year. It reflects tight control of margins and operating costs alongside our ongoing commitment to invest for the future. We also delivered a strong free cash flow performance, generating GBP 160 million at an 81% conversion rate. The group ended the year with GBP 31 million of net debt. The Board is proposing a final ordinary dividend of 27p per share, reflecting our strong performance and confidence in future growth. This takes the full year ordinary dividend to 42p per share, up 5% year-on-year. And we also paid a special dividend of 40p per share during the year. Looking in more detail at sales, customer and market share. We saw good sales growth across our total retail system of the total sales of GBP 1.64 billion, digital participation was 36%, up 1 percentage point year-on-year. Growth was broad-based across categories. Our winter warm range has performed well with customers looking for ways to offset escalating heating costs, and our summer living ranges for indoor and outdoor were well received when the weather got warmer. There was plenty of choice for customers as we added around 20,000 new products online. Our two sale events resonated well with customers, and we were also able to reduce prices on over 1,000 lines towards the end of the year. We were pleased to see more volume growth coming through our sales, particularly in the final quarter of the year. Our continued broad appeal was reflected in both customer numbers and market share gains. Our active customer numbers grew by nearly 3% with particularly strong customer retention and we saw high growth in 16- to 24-year-old customers and from customers in lower income groups. In the combined homewares and furniture market that was broadly flat and against a challenging economic backdrop, we were pleased that we grew our overall market share by 40 basis points to 7.2%. We grew our share of the homewares market by 70 basis points to 11% and whilst we maintained our 2% market share in furniture, we did grow our furniture sales by 4% year-on-year as we continued to build our customer offer and operating model ahead of FY '24. Now let's turn to gross margin. We exercised tight control of gross margin over the year and delivered a margin of 50.1%, in line with expectations. This was 110 basis points lower than the previous year, as expected, reflecting a return to pre-COVID sale and participation patterns and the impact of increases in input costs. With clear buying seasons, and with hedging and contracting policies in place, we have decent visibility of FY '24 input costs. We will balance a net tailwind from freight and FX with a strong focus on our commitment to delivering outstanding value to our customers, and we expect FY '24 gross margin to be around 100 basis points higher than in FY '23. When it comes to operating costs, we controlled costs well in a highly inflationary environment. Operating costs for the year were GBP 622 million, a combination of leverage from sales growth, strong operational grip and a drive for efficiencies helped to offset inflation, mainly wage inflation of around GBP 20 million and provided headroom for investment with only a modest increase in our cost to sales ratio. Volume growth added GBP 8 million of cost to distribution and performance marketing. The opening of three new stores and the annualization of the investments we made in distribution sites last year added a further GBP 7 million. Our productivity and efficiency savings of around GBP 14 million included the removal of excess costs in storage and distribution that we said we would remove. We invested a further GBP 22 million in technology and capability as we continue to build and optimize the digital side of the business, focusing on enhancing the customer proposition and improving efficiency. This helped us to evolve our total retail system and to grow sustainably. We expect wage inflation, in particular, to be an ongoing feature of FY '24, and we will partly offset this with further efficiencies. We believe that we're benefiting from a consistent and thoughtful approach to investment, and we will continue to look at what we need to do in order to seize the opportunities ahead of us. During the year, we tested the effectiveness of our brand and performance marketing expenditure, and the insight from this is giving us the confidence to increase investment in areas like brand marketing, helping us to increase reach. Whilst our focus remains on making every pound count because of the characteristics I've described, we expect our operating cost to sales ratio to increase to about 39% in FY '24. I'll now cover PBT, interest, tax and EPS. Net financial expense increased slightly from GBP 4.8 million to GBP 6.1 million, reflecting a higher interest rate environment and growth in our leased property portfolio. Profit before tax for the period was GBP 193 million, GBP 16 million lower than the same period in the prior year, reflecting a lower gross margin rate and a very tough backdrop for costs. We also saw an increase in the effective tax rate from 19.5% to 21.2%, primarily reflecting the increase to the U.K. headline rate of corporation tax, which increased in April from 19% to 25%. Diluted EPS of 75% was 9% lower than the same period last year because of lower PBT and the higher tax rate. Let's move on to cash generation and uses of cash. We generated GBP 160 million of free cash flow in the year, with a strong conversion of operating profit to cash of 81%. The value of inventory reduced modestly as we said it would do from GBP 223 million last year to GBP 211 million. As inventory levels eased, our working capital position stabilized finishing with a very small GBP 4 million outflow due to the timing of payments and accruals. GBP 19 million of the full year CapEx of GBP 22 million related to the opening of three new stores, 10 store refits and our continuing decarbonization program. We're pleased with the early performance of our newest stores and are learning a lot about introducing smaller stores into our total retail system. Nick will talk more about this later, but we expect to open 5 to 10 new stores, including relocations for each of the next 2 years. We, therefore, expect CapEx in each of those years to be in the range of GBP 30 million to GBP 40 million. GBP 38 million of cash tax paid reflects the increased rate of corporation tax. And just to note, FY '22 also included tax receipts relating to research and development claims from FY '21. -- And after payment of GBP 163 million of dividends in the year, the group ended with GBP 31 million of net debt compared with GBP 24 million in FY '22. Since the year-end, we've successfully renegotiated and extended our RCF for another 4 years to September 2027, increasing it from GBP 185 million to GBP 250 million to reflect the growth of the business. Moving on to dividends. The Board has proposed a final ordinary dividend of 27p per share in recognition of our strong performance and confidence in the business' future growth prospects. This takes the full year dividend to 42p, up 5% year-on-year and covered 1.8x by earnings, so within our earnings covered policy of 1.75 to 2.25x. In April 2023, we paid a special dividend of 40p. So we returned GBP 163 million to shareholders in the year -- we have a strong track record of shareholder returns, and we've returned over GBP 1 billion during the last 10 years working within a clearly defined capital allocation methodology. I'd like to conclude with some guidance for FY '24. We're pleased with another year of good results. These results were achieved despite a challenging macroeconomic backdrop, and while some of the headwinds that we've been negotiating have eased or are starting to ease, the inflationary and consumer environment is still complex. Our customers have responded very well to the choice, value and relevance of products in our range and have been very resilient to date. Whilst we understand that consumer demand is still quite unpredictable, we expect both sales and profit growth in FY '24 with the sales growth driven largely by volume. We have more certainty into our input costs in the way that we're managing margin. As I described earlier, we will balance net tailwinds primarily from lower freight costs with managing the challenges of an ongoing inflationary environment and always with a focus on outstanding value. We expect our gross margin to be around 100 basis points higher than in FY '23. We know that there will be further inflationary impacts on FY '24 operating costs, primarily labor related. And we expect to offset a large part of this through continued productivity and efficiency measures. At the same time, we remain committed to investing for growth and to take advantage of the opportunities we see. In FY '24, we will continue to invest to support our store rollout of continued digitalization and our evolving marketing ecosystem. On the back of new insights gained, we will spend more on brand advertising. As a result, we expect our operating cost to sales ratio in FY '24 to increase to around 39%. As we expect to increase new store openings to 5 to 10 per annum in each of the next 2 years, we will increase CapEx and to between GBP 30 million to GBP 40 million in each of those years. Because of some nondeductible expenses, our effective tax rate tends to trend slightly above the headline rate and therefore, we expect our effective tax rate for FY '24 to be slightly above 25%. So thank you for listening. I will now hand back to Nick, who will give more color on what we're doing to seize the opportunities within Dunelm.
Great. Thank you, Karen. So how are our plans evolving? Let's start with the market. And I think it's helpful to remind ourselves of some of the characteristics of the markets we serve. Firstly, house is a highly fragmented market with multiple product categories and customer missions. Many of those categories are needs-driven and low ticket, especially in homewares. Overall, the homewares market has proved resilient to cost-of-living pressures and will carry on doing so. Remember, we are a low-ticket retailer with an average item price across both channels of GBP 14 and an average basket size of just three to four items. Another characteristic of our market is that consumers are driven by emotional as well as functional considerations and are typically browsing rather than go seeking for a specific product when they shop. They're doing this online and in-store. Multichannel shopping is now established as the preference for most consumers and very few see themselves as being an online only or a store-only shopper. All this favors players with the ability to combine advantaged product with direct access to customers. That's always been the case, but now the tools to do it are so much more efficient and effective than ever before. So let's get into specifics. We'll dive into three areas of our a plan where we're seizing the opportunity. seizing the opportunity to strengthen our customer offer, in particular, with regard to value and creating joy for our customers. seizing the opportunity to extend and digitalize our total retail system with more stores planned and continued and significant technology developments and seizing the opportunity to evolve our marketing ecosystem with increases in investment and capability. Value, often talked about in this room. There are a variety of ways in which we are raising the bar on value for customers, and I'll bring some of those to life for you with some examples. One obvious and simple ways by lowering prices. And we've referred to price drops we've done in the spring, and we've also done some more in the first few months of this year. Remember, many of our prices didn't increase last year. So I don't want to overplay the scale of price drops. But this sofa in the picture is a good example of a bulky product, which we lowered by GBP 100 on the back of freight costs returning to pre-pandemic levels. Now every season, we reset our ranges across our good, best and better price quality tiers. And we've talked here in the past about doing that with examples in plain dye sheets. Towels is another interesting example of what we've done. We held prices a year ago on our best-selling Egyptian cotton towels despite raw material and freight increases. And at the same time, we introduced a new Supersoft range at our lowest priced quality tier of good at GBP 8 for all cotton 550 GSM weight bath towel. As a result of the value we're offering, we're seeing our volume share grow in core categories like bathroom textiles. Value is equally important at higher-priced tiers. In cushions, we've introduced new compositions using beading, sequin embroidery and wool blends, all handcrafted in India, which has enabled us to raise our prices at the upper tier to new price levels, while still offering outstanding value for money in the market. And we're passing on value to customers seeking more sustainable materials, pulling our more sustainable options into lower price tiers to make them affordable for more households. The Teddy Bear Throws we feature in many of our winter warm campaigns this year are made from 100% recycled polyester. And one final example, we're adding more choice in entering new areas by adding to our online range that's delivered directly from our vendors. We've added about 20,000 products of this type since FY '22, it's still curated product with the same product quality and price focus and allows us to learn about new areas and form new supplier relationships. Upcoming additions include more choice of nursery furniture and introduction this week of a range of live plants indoor plants and pots, which you can see online, if you look now. We've often talked here about value, but less about Joy this year, Joy is more important than ever before. It's in our purpose. But this year, while shoppers will work hard to be savvy and look for ways to balance price and quality to meet their budget, they're also looking for their experiences and purchases to be stress-free and joyful, an antidote to the graph and worries of making ends meet. You'll see our efforts to do this and how we talk to customers in store. We track fast and friendly feedback scores for every shop in the estate. You'll see it in how our marketing doesn't take itself too seriously. Even the food and offers in our Pausa Cafes are designed with an eye to Joy. Who could resist a giant coronation, Jammy Dodger with the jam in the shape of a crown. But it's in our core product development that we also offer Joy in a way that few other companies would do so. So I've got a short video now to show you of Debbie Drake, our Design Director, filmed at our recent London Press, our product show featuring our Autumn/Winter product. [Presentation]
There you go. And you can buy a Star Wars Death Star curtain video from us. Let's move on. On to the second deep dive, the total retail system. It's the best way we have, not the most elegant words, but the best way we have of describing one of the key advantages of our business model. it combines the benefits of physical stores with the convenience of online shopping and the reach of our marketing ecosystem. Our digital sales have increased in recent years. And at the same time, our stores remain fundamental to our success, not least by fulfilling an increasingly important role in marketing too and being part of their local communities. We've continued expanding our store estate with three new openings last year and our 180th store in Greenwich Southeast London opened in the summer. Now looking forward, we see opportunity in the next couple of years to accelerate our run rate of new store openings. This reflects recent learnings and improved data and insight capabilities, the typical Dunelm superstore has approximately 30,000 square foot of trading space, including a 10,000 square foot mezzanine and is in and out of town location. We're delighted with the returns we generate on stores like these and [Waymo's], a recent example of a new one of those we've opened. But at the same time, as you can see on this graph, we've opened four smaller stores recently averaging around 15,000 square foot, and we've also opened the full-sized ones in town center locations in recent years. And we're seeing the same good returns across these different types of openings with paybacks averaging just under 3 years. With this and with now better insights to support location planning, we expect to open 5 to 10 new stores, including relocations in each of the next 2 years. These will be full-service NM stores, amplifying our online offer and driving local customer awareness to enable them to benefit fully from our total retail system. We will, of course, apply our usual operational grip and discipline to these investments and monitor the progress of the smaller stores in particular. At the same time, as expanding our physical reach, we continue to digitalize our total retail system, building and now also optimizing to improve our customer offer and increase the efficiency of our operations. We're leveraging our data foundations, building data fluency and enhancing customer stock and product data quality. And we're doing all this with our own in-house capabilities and with those of our core partners. On the left side of the table, you can see some of the milestones achieved in the last 6 months. We are pleased to have increased customer retention as we improve perfect order rates and the quality of our delivery and aftersales service communications are also improving. More convenient payment options such as Klarna and better product data support site conversion rates. In addition, new product master data management tools will improve our data quality and allow our category teams to be more efficient. Over the next 12 months, we'll further improve our website experience with smarter search tools and faster site architecture with micro front ends being deployed in our architecture. We'll continue to expand our product offer with new ranges and made-to-measure categories like shutters and fitting becoming available online for the first time and to improve the efficiency of our operations, we'll launch new tools we're forecasting and replenishment and optimizations to improve stock handling in our warehouses with both of these initiatives also improving availability for our customers. We'll also increase our personalized communication with customers, and that brings me on to our marketing opportunities. So turning to the next slide. The third and final of our deep dives is into our marketing ecosystem, which refers to our brand marketing, our digital performance marketing and our local community presence. We continue to develop at pace and are learning lots along the way. Some of our more recent learnings have come from a greater understanding of consumer attitudes to the home and home shopping. And we've recently conducted a significant piece of work, giving us more insight into the customer opportunity for this next phase of our growth and who we will target. We observed some different attitudes to home spend compared to pre-pandemic and have gained an updated view of the groups where we have the most headroom for attracting new customers and growing shopping frequency. The four themes on the right side of this slide gives you a broad overview of some of the high-level findings. Firstly, and encouragingly, the home remains front and line for consumers, albeit we are more aware of the variety of reasons consumers have for their interest and how well our brand meets those needs. While for some of the home is a place for a family, for others style and creating a venue for entertaining rank much more highly. We see varied attitudes towards value also. While important for everyone, there are increasing differences between consumers in terms of price sensitivity and attitudes to credit. With these insights, we can target our customers with marketing content more competitively and with more personalization. The lower two boxes speak more to our brand marketing opportunity. We've grown strongly in the Southeast and with younger consumers over recent years, but there's still a lot more to do, and we remain significantly less well known in London and amongst younger customers than we do nationwide. At the same time, nationwide, even for customers who know us well, we are top of mind in less than half of the categories that we now offer. It's still early days in applying these insights. But as we begin to integrate them into our customer database and our marketing approach, the better we can attract new customers and grow frequency. As we've shared in previous presentations, our best customers are multi-category multichannel shoppers shopping 5x as often and spending 7x as much. So two developments of note to share this morning. continued building and optimization of personalization and a step-up in our brand marketing beginning this autumn. In terms of personalization, we are combining data from multiple sources, including demographics, and previous purchasing behavior to begin a more targeted and personalized level of marketing, including optimizing the time at which we send communications to you and customer-specific product recommendations within marketing e-mails. We're also testing a more customized website where paid search will lead you to a personalized dunelm.com landing page with a greater range of options beyond the specifically search for product. We continue to make progress in the quality of data stitching in our single view of customers across both of our channels, the same payment system that we rolled out online last year is now running in 40, almost 50 of our stores, the remaining ones following by the end of this calendar year. And cross-channel payment tokens are now flowing into our marketing -- our customer database from these migrated stores. It's worth just framing why personalization is capability we are so focused on. The combination of advantaged own brand product and direct to customer access is a central access of our business strategy. The more we can tailor content, especially the products we show to a customer than the more effective our marketing, doing that at scale, informed by genuine customer insight and with the content generation becoming more efficient due to AI, that is very exciting. And our brand marketing, we simply want to establish our presence and the quality of our offer in more categories to become, if you like, the home of homes. We have the insight and confidence to do this, as Karen mentioned, from the rigorous incrementality testing we did last year. Our new brand campaign is launching this autumn. You can see us still from the film on the slide, and it's on screens from next week, which draws an end to the three deep dives. I hope you enjoyed them and you get a sense of why we are so confident as a team for the future opportunity. I'll describe in summary, FY '23 is a good year for performance with strong sales, robust profit and excellent free cash flow, but it's the strategic progress that excites us most by continuing to invest across all of our growth levers, and in our colleagues' well-being and capabilities, we are so well placed to seize the growth opportunities afforded by a fragmented market, of which we have a just 7% market share. Customers are seeking value at all price tiers. While some are searching for low price as necessity, others are now feeling more confident than they were a year ago. In this environment, our brand value proposition and its breadth of largely owned brand product and multichannel offer is resonating very well. Focus on operational grip, as you would expect, continues to be a feature and critical to our success, and we expect to see slightly increased gross margins and at the same time as we reset our ranges to offer outstanding value for money. In terms of operating costs, it will be another year of mitigating some of the inflationary effects we are seeing and in parallel, continuing to invest in our offer, our retail system and in our marketing. Trading so far this quarter has begun well. And as a result of this and of all of our plans, we are confident for the future and the year and years ahead. Thank you so much for listening. We're now delighted to take your questions. So Karen is going to join me at the front. We'll get ourselves organized.
We're going to do it from the -- hands over here appearing. We're going to do it from the room first. We do have some guests online, so we're going to go to them afterwards. There's some microphones. It will be great, particularly for the virtual guests, if you could just give your name and institution when you start. And I wouldn't try to limit the number of questions because I know that will be futile. But there are -- we've got great attendance. So it would be good if you could ask your main questions first.
Okay. I'll go for two. John Stevenson of Peel Hunt. You mentioned obviously the small store in terms of payback and everything else. Can you talk a bit around what they actually do to the surrounding areas and the softer stats. So what's happening to brand awareness, active customers' frequency and spend, particularly somewhere like Greenwich, I don't know if we could use one maybe as a bit of a case study. And second question just on sort of the digitization piece. I mean, again, we talk about that about sort of KPIs and personalization, particularly around the website. Can you talk a bit more about the rest of the business in terms of what's happened over the last 4 or 5 years, it feels like the insights are kind of everywhere. You can maybe give a bit more detail.
Okay. Great. Should I take those, Karen, and please add in if you think you want to add anything. So I mean, it's interesting. So we've only recently closed our last High Street store in Boston and Lincolnshire, and now we're opening smaller stores. There are different shopping missions in homewares. There wasn't a convenience homeware shop. The smaller stores are full strength, full fat, if you like, Dunelm stores. Catering for our main shopping mission. They're just smaller. And they're smaller because they don't have a cafe and they have a very much reduced furniture assortment. But they're still, to a customer, a full-sized Dunelm store. So when we opened in Greenwich, recently, that's a 15,000 square foot store. We had between 5,000 and 10,000 followers of our local Facebook group, the day the store opened. And for customers visiting it, and I was there recently, for them, it's just a convenient location in a catchment, which we were underserving previously. And whether they're an online mostly shopper. In most of our categories, consumers will want to check in store and check a color of a curtain or have the reassurance they can take it back to a store if something goes wrong. So they're an integral part of being in a catchment and growing our overall market share.
I don't know if you can sort of share any numbers around what it has done to [indiscernible] positives to post-COVID sales.
Yes, opening store lifts. I mean, yes, I mean, the story of the business is, as we open more stores, our online sales grow as our online sales grow our stores growth sales grow, too. And sales densities increase in stores, that's even more the case when we open is all for the first time, whether that's in an urban area where we are underrepresented or infill in a populated area. So it's an amplifier of the total retail system rather than just a one-off of the store. In terms of digitalization, it's a long word. I mean we increasingly see it in other people's communications. I mean I guess when we began the journey, we didn't know where it would end and we probably still don't know where to end. We thought data was mostly about more insight and more analytical understanding of the business. What we're now learning is that it's actually changing the fundamental operations of the business. Our whole performance marketing spend is running on algorithms with a very small team operating it as we gain more mobility. It will be the same in content creation, and it will be the same in personalization. And that, I guess, the ability at scale to do personalization cost effectively when you have own brand product is transformative to how we think about the opportunity to market our products and bring them to market. So it's changing the business very profoundly. Very good. Thank you. Next question.
David Hughes from Stifel. In terms of the productivity savings that you've kind of got planned for next year, is there any kind of insight on what the size and scale of them? Have you identified specific savings already and when those might start to kind of come through?
Well, I mean, what we said in terms of scale is that we would expect to offset a good part of the wage inflationary pressures with these productivity and efficiency gains. I think it's important to say that when we're looking at efficiency and productivity, that's what we mean. We don't tend to go in for what I call the tea and biscuits cutting. So we want sustainable improvements in our operating model. We have, as you can imagine, a program of continuous improvement in our operations, whether that's our store operations or our distribution centers. So we carry on with that year in, year out. As Nick alluded to, is we are developing the marketing ecosystem, we're becoming more efficient and more effective. So we get efficiency gains out of the way that we're utilizing the digitalization there. And then maybe two sort of almost more tangible areas that we will expect to take productivity savings from. One is double deck of vehicles and our distribution centers. So I mean, that's actually good for efficiency, and it's also good for the planet because you're reducing the number of journeys and those have been recently introduced. And then the other thing, which Nick alluded to when he was going through his slides was retention, staff pension. And I think we mentioned that about this time last year that the more that we can retain staff, that becomes a really important driver of efficiency because you're saving in recruitment fees, you're seeing in training, and you've got a workforce that is high up the learning curve as opposed to people who are still learning. So that's where I would give you some examples of the stuff that we're focusing on. We don't have a silver bullet. It is retailers detail here.
And then one more from me. On the conscious choice range, you said that that's up to 15% now. Can you share details of kind of where that's come from? And do you have a target in mind of how much of your range you want to get in included in that?
Yes, the target is all of it, which should be -- so we use conscious choice as a way of making sure that we're pushing -- raising the bar, if you like, on bringing more sustainable materials into our range as they become available. And every year, we'll aim to increase that. Our target in cotton, for example, is will be 100% from our most sustainable sources within a couple of years' time. But it's a balancing act, as you heard in government news this week, affordability is also critical. So making sure -- is there a bad feedback on the microphone? Can you -- okay. So making sure that's affordable is also critical. So recycled polyester in our winter warm Teddy throws this season is the first time that's happened. It's at the same price as the throws were last year. I've got a few more hands up, coming around.
My name is Matthew Abraham from Berenberg. Just the first question just is in reference to the gross margin guidance. So you called out freight costs as a tailwind there? And then you also said that operational group would be a benefit. Can you just attribute how much of that 100 bps is today from the benefit of those two factors? And how much might be from that volume growth that you mentioned?
Yes, I mean, we're facing very similar questions last year. There's a lot of moving parts and the moving parts are different in proportion in different products from a towel to an occasional chair. But in broad terms, you think about our billing materials, you've got raw materials, which are mostly flat year-on-year, cotton is up 8% because the harvest in China was poor this year. You've got freight, which is significantly a tailwind. You've got factory capacity where there's significant opportunities across most of our markets. And you've got -- we hedge our FX. We've got a slight headwind in FX. How that flows through into each product will differ in terms of the proportion of costs and size of the product. We then do is optimize to offer outstanding value for customers, and we're seeing pretty rational pricing in the marketplace. And we then have a very firm operational grip on our gross margins. And between those two, we have a variety of ways and I've given you examples, countless examples of how we think about it. In terms of holding price changing materials and keeping the price the same, dropping prices, and we'll do all of those things as appropriate. And that's really what's driving our relevance for customers as they seek to make ends meet.
And one more, if I may. So this query is just in reference to your comments on the end market, which you said was largely flat in the last 12 months. You then called out [indiscernible] strong volume growth in that last quarter, which you've said is carried on in the first 10 weeks of this financial year. Is that then to say that you've generated further market share gains in the first 10 weeks? And is that consistently tracking with how you exited the last financial year?
I mean that's what we have typically done through our history, which is we've grown, and as Nick said, the average growth rate has been 10% per annum, and that's really largely come through market share gains, and that's just what we typically see.
It's Andy Wade from Jefferies. I think I'll stick with two, then as everyone else is on to overcook things. First one, if you look at active customers and market share gains, both of them slowed both from FY '22 and from the first half, in particular, if we look at the share gains, it was up about 160 basis points in the first half and 70 basis points for the full year. So it was flattish in the second half. So just if that's the right math. Just interested as to whether there's any concern that those are slowing down in terms of the trend?
No, we're really happy with the market share gains, and we can talk about furniture as well, if you like. The data source we are using there is an annual data source. So I can't give you a first half, second half split. We also get data weekly from GfK, which is a panel, which is -- gives us another read on the market. And we remain incredibly confident that we're gaining substantial market share, and it's sustaining. I mean, obviously, in the year, our sales growth was just short of 6%. So in the previous year, it was more than 6%, and the market share growth was higher. But more, as Karen said, more of our market -- of our sales growth came from market share last year because the market was broadly flat.
Okay. Okay. And then looking at your SKU count obviously increased quite substantially this year. And your revenue grew a bit. So -- and I appreciate some of this drop ship and so on, but it will have taken some volume from your existing lines. So just interested as to whether there were any challenges having sort of lower volume per SKU on the existing lines, whether difficult conversations are required maybe not difficult, but how that was managed and so on.
Not difficult. I mean, not all lines are equal. So the range we're adding, which you call drop ship, we call direct-to-consumer from vendors is not stocked by us, it's typically in categories where we have a very low presence, nursery furniture, or where we're not present, life plants. And it's a great way of us entering new categories. So it's interesting. I mean, 5 years ago, we were saying we were going to grow the range and actually it didn't grow. And we've chosen never to launch a marketplace. We like curating the assortment. It's really important to us. It's our curation. And we have the same quality and price expectations on the extended range from vendors. But it's mostly in new categories. And it's a way of learning and a we are finding out. I mean rates of sale will be relatively low on those categories compared to our best-selling products that across our retail system and in our stock base, but it's a great way of us to learn and to broaden our offer.
Okay. I was also going to ask what the Star Wars lady's dogs were called, but I suppose -- that's a third question, I suppose, so I'll leave that one.
Hiba Ali from HSBC. The first one I have is on capacity withdrawal. So how much did that impact FY '23, the year has gone on sales. There is a fragmented market, as you pointed out, but there have been some high-profile exits like Wilco and made.com with which you would have some sort of overlap.
Yes. I mean, again, a question is often asked. The answer is, the market is just very fragmented. Even when we've had major players like British Home Stores and Lighting exit the market many years ago, lighting is 10% of our sales. They may have had 10% of the market. even if the stores were adjacent, you see a very small effect. But obviously, in the round, as we gain share, the market is somewhat consolidating but we don't see direct effects like you've just drawn out.
Okay. All right. And when can we expect another special dividend? Can you do a recap of the capital allocation policy, please.
Yes.
Well, a recap on the capital allocation policy. Well, capital allocation policy is that we aim to distribute a progressive ordinary dividend, and that's what you saw with the 27% -- 27p final dividend and a 5% year-on-year growth. And then we look at -- and that's to be covered 1.75x to 2.25x by earnings. And so this year's dividend was covered 1.8x by earnings. And then we look at our net debt-to-EBITDA ratio, and we say that we'd like to be consistently in a range of 0.2x to 0.6x. Now at the balance sheet date, we were actually at 0.1x, so just slightly outside of that range, but not consistently. And for instance, if you added in the impact of the 27p dividend, then you would be at 0.3x. So that's what we're constantly looking at and also making sure that we're investing for growth in the business. You'll see that we're a CapEx-light business. We're slightly increasing our CapEx guidance for the next 2 years to take advantage of store rollout opportunities. Most of our investment actually goes through our P&L.
Charlotte Barrie from JPMorgan here. I have two questions as well, please. Firstly, just following on from capacity exits. From what you're saying, it sounds like the accelerated rollout is purely a function of the insights you've gained on the new store types and not necessarily capitalizing on capacity exits over the next 2 years, but interested to hear comments on that.
Correct. It's -- yes, it's driven by what we think our customers want and how our model is developing.
Okay. And then secondly, on furniture, which you mentioned, obviously, market share was flat in the period. Do you think you'll be adjusting the way that you think about investing for growth in that category? And then other new categories that you move into? Or do you feel that the return on investing in homewares at the moment is just so much stronger and your focus on that?
No, we are focused on both. I mean even words like homewares and furniture, we don't actually use back in the office. Furniture is probably a dozen subcategories each with different dynamics, each with different competitors, and homewares is 30 different subcategories, and we look at the resource allocations we make with an eye to opportunity and the returns we're getting, and we're seeing equally good returns, putting effort into furniture as we are into the homewares categories. We were surprised that with 4% sales growth, we didn't gain market share. but the data source that we've used consistently over the years indicated that that's what it was. If you dive into furniture, actually in upholstery, we have particularly good sales with our sofas and occasional chairs, and we were delighted with our sales progress there. We were less happy in cabinetry. So cabinetry, so occasional tables, bedside cabinets. We didn't have a great stock base. We were quite fragmented coming out of the waves of lockdowns and freight challenges. And in the category that's more driven by online sales, being in stock of bestsellers is really important. So our stock base now is lower, but higher quality than it was a year ago. So we're feeling lots of operational opportunities at the same time as investing in the breadth of our product opportunity. Great. There's a few more in the room, and then we're going to go virtual. Yes. Let's go with Manjari.
It's Manjari Dhar from RBC. I also have two, if I may. With given the sort of the new format stores that you guys have been rolling out, as you look at the store estate and the potential number of catchments that you could be in, do you see upside to that target that you have for the longer term?
Well, we've never been that prescriptive on the endpoint. When we IPOed the business, we talked about 200 to 250 catchments, which we thought supported our economics. Now a lot has changed since then, but in some ways, lots hasn't changed. Our market share is only growing slowly and the market remains fragmented. We'll see how the smaller stores do. We're really confident in the metrics we're seeing so far. But we really judge us to by how well it's maturing 10 years from opening and driving incremental densities in a store that's been established for a long time. But if you were to ask me 5 years ago whether we'd end up with 200 to 250-odd. I'd probably focus at the lower end of that range. Now with what we see I probably focus at the higher end of that range, but we'll see. And we don't need to make those choices now, we'll judge it in a more entrepreneurial way.
Great. And in terms of sort of online and off-line dynamics, have you seen any sort of shifts in where consumers are choosing to spend recently and perhaps driven by the addition of the [20,000] SKUs online?
No. I mean, stepping back, the big story is, in the year after lockdown, everyone was surprised by how well the stores did. For us, in FY '23, we were delighted by how well our digital sales progressed in a year, which was harder for many digitally focused businesses, but the stores are really strong, too. And then conclusion actually having both is really good. And we see customers increasingly wanting to shop across both, and we did a segmentation study recently, customers no longer define themselves by how they -- where they shop by channel. Most people think It's just natural to use both.
Richard Taylor from Barclays. Two questions as well, please. Just wanted to understand your trade-off with the freight rates windfall and gross margin. You said that you expect volume to lead revenue growth yet you are taking 100 basis points on gross margin. So just trying to understand how you balance those factors out and why perhaps you didn't state gross margin near 50% slight your long-range guidance is and go for even more on volume. Then the second question was on the bank facility. I appreciate the business got bigger in size, but you've not been M&A focused historically. So anything we should read into a bigger RCF for just the business is growing.
It's a great question in terms of the volume price trade-off. And I did say that we are seeing very rational pricing in the marketplace, and we like to keep our trading powder dry in terms of reaction both what we're seeing from consumers and what we're seeing from competitors. We think we've got the balance right. I mean that's quite a sophisticated balance across 50,000 SKUs that are in stock and the 20,000 next year I mentioned earlier on. And we have various ways of adapting during the year and what we need to do, but we think that's the right balance now. Obviously, as freight rates come down, they flow through our stock file gradually. So all these things we balance and trade-off and land in the areas that we've guided to. But we're feeling very strong about our value proposition in the marketplace, but we also think the group is good, too.
And then just on the RCF. I mean I'm actually really pleased that we're looking for a bigger RCF to support our growth, and it's been very well supported by the banks in our banking group. And because we're not CapEx heavy, we don't have terribly lumpy cash flows what you see is the cash flows are really dictated by our working capital cycles. So at the end of every quarter, we've got rents going out, we've got VAT going out and then we've got the wage bill as well. And it's really just making sure that within those dynamics, we've got adequate liquidity to do what we want to do, including investment. No, we're not M&A focused because we think we've got a really strong organic runway ahead of us, but we also feel secure about having the firepower that we need for opportunities that come along. I will be very focused on doing everything I can to optimize the working capital position. And that was why I did say we had brought the inventory levels down a bit. We said we were going to and we did that towards the end of the year, which is when we said we would bring them down. So I think for now, going forward, we've got a more stable working capital position because of our inventory levels.
Do we have any questions from our virtual Audience? I don't see any hands raised. Any more from the room? If not -- Georgios.
Georgios Pilakoutas from Numis. First one on stores, why only 2 years for the 5 to 10 higher store growth? And then can you just remind us mechanically how we should think about stores translating into sales might not be -- just all of them would be helpful. Then on the marketing spend, if you just talk a little bit more about kind of balanced business, performance marketing, this is above the line. How are you going to be measuring returns on that? And externally, how should we be judging you kind -- you just made that entire marketing spend? Is it higher sales we should be looking for? Is there a particular channel that should be coming through, et cetera?
Great. Good questions. So I mean on stores, why 2 years? We thought just saying it for a year would be a bit short. And therefore, we did 2 years because we actually -- it's an inflection point in our thinking around our confidence around this smaller format, but we've only been opening them for a couple of years, and we want to carry on seeing how they trade and how they perform, but we're very confident that they will do and the customer reaction so far has been fantastic. And mostly if we engage them to think actually they are involved, which is a test. So we're very confident, and we'll see how they progress. I'll just -- we're not go seeking to have as many stores as possible. The art of this business is to connect a unique product with customers efficiently and effectively. And you can overinvest in channels, whether digital or physical, you can under-invest in them, and we want to get the balance right in terms of how we think about channel investment. And we're doubling, but we're doubling only to 5 to 10, and we'll carry on seeing how we get on. Their sales densities will be equivalent to a normal store. So we can give you some guidance as to the mix of smaller and larger ones as appropriate during the course of the year as we get various deals coming through, but the sales densities will be similar between smaller and larger stores.
It will be a mix and our portfolio will still be weighted towards 30,000 square feet because that's what the majority are.
Marketing spend is a way of accelerating things that are already happening. So we are already gaining share. We're already getting customers. We're gaining customers with younger consumers and also in the Southeastern London, we think that having a higher brand awareness and consideration will accelerate that trend. We're a growth business, judge us by our post-IPO compound growth rate 10% in the last year, we had to get all of our 6% from share gains. I think the stat over the longer term is 80% of it has come from share gains. It was ever thus, the balance will change from year-to-year occasionally. What will the market be like in the year ahead. We're very confident in our share prospects. Our share gains have never been underpinned more robustly with things that we've been working on for multiple years, and we'll see what happens to the market. It was broadly flat in the last 12 months, which probably sat here a year ago, we would have taken. So let's see where we are in a years' time. We're very confident in our market share prospects judge us by that.
Real quick follow-up. You just mentioned that the sales density of the smaller stores is the same per square foot as the larger stores, presumably, the rent per square foot is a bit higher than out of town destination stores. So are they lower profit per square foot?
Well, no, because we get the right deals and we are choiceful about where we open stores and we've never been a retailer that needs to be with neighbors to have the right footfall, we can generate our own footfall. So we search for the best deals. And actually, at the moment, you can get good deals in town, sometimes that you can't get in retail parks, so we like being flexible.
We haven't changed any of our internal hurdle rates and the business case requirements are just the same as they've always been.
Yes. I mean there could have been lower CapEx, I suppose, per square foot. I don't know there's a balance there.
But see the sales as the effect on the catchment. Irrespective of the density times the size of the store, the catchment opportunity is the bigger prize.
Understood. Thanks.
And on that specific and final question, we're going to call it a day. Thank you very much. We are doing -- unusually for us, we're doing an event in November, November 9, which all analysts and investors are invited to. We're at home at our next product show. So we'll be able to visit that and we're going to spend some time giving you more information around some of the technology and customer work that we're doing, and you'll have a chance to meet with all the team. So I hope to see many of you at that and look forward to it. Thank you for your questions. Thank you for your interest.
Thanks very much.