Sit on DFS for the long term

DFS had the biggest share of the UK’s upholstery market, with 34 per cent last year. Its main DFS brand targets average income buyers and accounted for 73 per cent of sales. Other brands cater for those that would not normally consider buying from DFS, which the company put at about a third of consumers.

It has a knack for acquiring distressed competitors, having bought Sofa Workshop and Dwell – which cater to wealthier customers – out of administration in 2013 and 2014, respectively. 

DFS’s online gross sales orders rose 24 per cent between 25 March and 19 April, lifting its order bank from £185m to £194m. Wear and tear is a leading reason for replacing sofas. According to research by broker Jefferies, of those who have bought a sofa in the past two years, nearly two-fifths did so to replace an old or broken sofa. Given only 23 per cent of consumers have bought a sofa in the past two years, the wear and tear created by homeworking could boost demand for upholstery. 

The short-term picture is mixed. Consumer credit use is a driver in the sofa market, but savers opted to repay a record £7.4bn of credit in April, according to the Bank of England, which was accompanied by an unprecedented drop in retail spending. Over half of DFS sales are paid for with its interest-free finance. Importantly, this is provided by external finance houses that carry default risk in return for a fee. This should limit DFS’s exposure to bad debts during recession.

Investors should also consider DFS’s "negative working capital". Most of its products are made to order. DFS collects payments through deposits before delivery, or upon delivery, and pays its suppliers afterwards. This is a good source of cash when the business is growing, but can be a drain when sales fall.

However, DFS has restructured supplier payments to limit the unwinding of this negative working capital to £70m. It has covered this outflow with a banking facility of equal value. DFS also raised £64m via an April share placing, and its new financing affords it sufficient liquidity for the rest of 2020.

The model helps keep the balance sheet lean in other ways, too, with an inventory to sales ratio of just 6 per cent last year. 

DFS’s flexible cost structure has also helped it through the crisis. Over 85 per cent of its costs are variable, and the fifth-highest spender on advertising in UK retail has delayed this expenditure into autumn.