Why I won’t be buying DFS Furniture plc after 20% drop

Today’s profit warning from DFS Furniture plc (LON:DFS) could be a warning for investors.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Shares of sofa retailer DFS Furniture (LSE: DFS) plunged 20% this morning, after the group warned that 2017 profits would be significantly below expectations.

According to the firm, trading conditions have “recently weakened beyond our expectations” and there has been “a material reduction in customer orders”. Full-year earnings before interest, tax, depreciation and amortisation (EBITDA) are now expected to be in the range of £82m to £87m.

Taking the mid-point of this range, this means 2017 EBITDA is expected to be 10% lower than in 2016 (£94.4m) and 5% lower than in 2015 (£89.2m). Management believes that this reduction in demand is “market-wide” and results from caution relating to the general election and “the uncertain macroeconomic environment”.

Should you invest £1,000 in National Grid right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if National Grid made the list?

See the 6 stocks

I’m not totally convinced that the election and Brexit are to blame. I think a more likely explanation is that customers aren’t sure they can afford to pay for new sofas, even if they take advantage of DFS’s current four-year interest-free credit offer.

What does this mean for investors?

I estimate that based on today’s profit warning, earnings forecasts for the current year may be reduced to about 21p per share. With the stock trading at 196p after this morning’s 20% fall, that gives a forecast P/E of 9.4.

That may sound cheap, but if consumer spending really is slowing, sales could have much further to fall. Profits could slide. I don’t agree with DFS’s decision to pay a special dividend of about £20m this year, while still maintaining a gross debt balance of almost £200m. In my view, it would have made more sense to clear this debt while the going was good.

If I held DFS shares, I’d probably sell after today’s warning. I don’t think holding the shares is worth the risk until we see whether trading stabilises later this year.

How to make money from falling sales

Falling sales are bad news for cyclical businesses such as sofa retailers. But for large defensive stocks like British American Tobacco (LSE: BATS), they’re not necessarily a big problem.

Tobacco sales are falling globally, but BAT has dealt with this by acquiring rivals and consolidating its brands into a smaller number of larger Global Drive Brands. On Wednesday, the group said that it expects to outperform the forecast 4% drop in global tobacco sales this year.

Analysts expect the firm’s full-year adjusted earnings to rise by 14.9% to 284.3p per share in 2017, putting the stock on a forecast P/E of 19. The dividend is expected to rise by 10% to 186.8p, giving a prospective yield of 3.4%.

I think these shares are starting to look expensive, especially as exchange rate effects are expected to provide a 14% boost to earnings per share during the first half. These benefits may reverse at some point in the future, putting pressure on profits.

I’m also concerned about debt levels. In 2011, net debt was about £8bn and after-tax profit was about £3.1bn. Since then, net debt has risen by 115% to £17.3bn, but after-tax profit has only risen by 50% to £4.7bn. Acquiring additional market share seems to be increasingly expensive.

These two factors make me cautious about this stock at current levels. Although I’d continue to hold BAT for income, I wouldn’t buy any more at current levels.

But there may be an even bigger investment opportunity that’s caught my eye:

Investing in AI: 3 Stocks with Huge Potential!

🤖 Are you fascinated by the potential of AI? 🤖

Imagine investing in cutting-edge technology just once, then watching as it evolves and grows, transforming industries and potentially even yielding substantial returns.

If the idea of being part of the AI revolution excites you, along with the prospect of significant potential gains on your initial investment…

Then you won't want to miss this special report inside Motley Fool Share Advisor – 'AI Front Runners: 3 Surprising Stocks Riding The AI Wave’!

And today, we're giving you exclusive access to ONE of these top AI stock picks, absolutely free!

Get your free AI stock pick

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any shares 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.

More on Investing Articles

Investing Articles

What’s up with the Lloyds share price?

The Lloyds share price is up 26% in 2025, representing one of the strongest performance on the FTSE 100. Dr…

Read more »

Mature Caucasian woman sat at a table with coffee and laptop while making notes on paper
Investing Articles

Here’s how a 40-year-old could start investing £100 per week to retire early

If a 40-year-old decides to start investing today, here's how they could potentially turn £100 a week into over £500k…

Read more »

A pastel colored growing graph with rising rocket.
Investing Articles

The FTSE 100 is up 60% in 5 years. Here’s why — and a big lesson!

The flagship FTSE 100 index has put in a very strong performance over five years. There's a specific reason for…

Read more »

Investing Articles

How much do investors need in an ISA to earn a £2,500 monthly passive income?

Charlie Carman explores how investors could strive for £30k in tax-free passive income each year from a dividend stock portfolio.

Read more »

Investing Articles

How much would a 45-year-old need to invest in an ISA to earn a £1k monthly passive income at 65?

Harvey Jones looks at how much an investor would need to put away every month to build a steady passive…

Read more »

Investing Articles

3 things to do ahead of the new 2025-26 ISA year

It's time for us all to put on our investing boots and get to work on developing our plans for…

Read more »

Older couple walking in park
Investing Articles

Is £150,000 enough to generate £1,000 a month in passive income?

Stephen Wright takes a look at three UK stocks with dividend yields above 8% that passive income investors might be…

Read more »

Investing Articles

Aim to earn a £50k second income in retirement by investing just this much each month

Even with a small monthly investment, it’s possible to earn a £50k second income with a successful investment strategy and…

Read more »