Dunelm has done well and looks inexpensive – should you invest?

These are tough times for big retailers. They are beset by the cost of living, uncertainty about the global economy and rising staff costs, especially after the recent increase in employers’ national-insurance contributions. However, some well-run retailers have managed to rise above the turbulence.

One of these is Dunelm Group (LSE: DNLM), which we successfully tipped three years ago in issue 1114, selling in issue 1152 for a profit of £789. This proved to be a wise decision, as for the next two years the stock largely trod water. Lately, however, it has started to take off, so this is a good time to consider another punt.

Dunelm sells home furnishings, ranging from furniture and garden equipment to bedding. Over the past few years, it has demonstrated a knack for finding products that people are interested in buying and pricing them at levels that are affordable, without discounting them too heavily.

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While it has consistently grown the number of stores that it operates, it has balanced this expansion with investment in its website, allowing it to benefit from consumers’ gradual move online. More recently, it has tried to offset the rise in national insurance payments by boosting the number of self-service checkouts and by working hard to improve efficiency.

Dunelm's rivals will struggle to match up

The upshot is that Dunelm has prospered as others have stumbled, increasing its market share to 7.7%. Sales have increased more than 50% over the past five years, and the latest figures suggest they are still on the rise. While the entrance of the US retailer Pottery Barn into the UK market is a potential threat, the new arrival will take some time to establish itself, and Dunelm’s efficiency and recognisable brand should help it rise to the challenge. At the same time, Dunelm’s purchase nine months ago of Irish retailer Home Focus provides scope for expansion, as well as making it less dependent on the UK market.

Dunelm boasts solid operating margins and an excellent return on capital employed, which has consistently been greater than 40%. It also has relatively low levels of debt, which should sustain it even if consumer confidence suddenly declines. The stock still looks very attractive, however, trading at a modest 14.6 times 2026 earnings. Even better, it offers a dividend yield of 5.5%, which is much higher than the average of 3.6% for the FTSE 350 as a whole.

Dunelm’s shares also have plenty of momentum behind them. They are trading above their 50-day and 200-day moving averages and have outperformed the market over the past three, six and 12 months, with several brokers recently upgrading their price forecasts. I therefore suggest that you go long at the current price of 1,169p at £2 per 1p. In that case, I would put the stop loss of 769p, which gives you a total downside of 800p.

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