A Candle in the Wind?

Over the past few months, GC1 has been accumulating shares in Dusk.

Dusk is a home fragrance retailer which sells products such as scented candles, diffusers, and essential oils. The company is fully integrated, from manufacturing its own products to distributing through their own network of more than 140 stores across Australia and New Zealand.

A recent sell-off in the consumer discretionary space due to macro-economic fears has created an opportunity to own shares in the retailer at a compelling price. At last close, Dusk trades on a forward EV/sales of 0.5x, 3.2x EBIT and a P/E (ex-cash) of 4.8x.

We believe Dusk is currently being priced as a low-quality retailer which is likely to see its earnings decline as cost-of-living pressures rise and consumers cut back on discretionary spending. Our view is the opposite.

Dusk has a strong competitive position (~25% market share) in a niche market coupled with significant advantages over its competitors which should see its store economics sustained over the long term. The low value, highly seasonal nature of home fragrance products means that considerable scale and lean operations are required to profitably run stores. This is best illustrated by Dusk’s sub-5% margins when it had fewer than 100 stores.

This means that any potential competitor in this space would need to run close to 100 stores to break-even, in a country that can only support ~150 stores, with a total market size of ~A$500m. This would take a new entrant/existing competitor a long time to build and cost a lot of money to compete at scale.

Further, given the home fragrance market is a ~A$500m industry, no large player (e.g., Amazon, department stores, etc.) would think it’s seriously worth their time/energy to focus on trying to meaningfully compete with Dusk in such a small market.

Dusk is better insulated from a recession than most other specialty retailers considering “gifters” make up approximately 30-40% of the company’s revenue. Even under the most pessimistic scenario, people are still going to buy affordable luxuries such as candles to gift for Mother’s Day, Christmas, birthdays, etc., or even for themselves.

The company is run by an experienced managed team with a track-record of executing and a material interest in the business, owning >10% (or $10 million) of the company.

Management has a target to reach 165 stores across Australia and New Zealand. Dusk opens ~10 stores per year, meaning they have at least another two to three years of runway in Australia and New Zealand before reaching maturity. Management have also previously spoken about their medium-term aspirations to enter the UK, through the opening of a pilot store. Although we place no value on this possibility, we do view this as having significant upside optionality if the company were to successfully expand outside of ANZ.

We believe the current setup presents one of the most attractive risk/rewards in markets today.