Stock: Billabong International Limited
Stock code: BBG
Share Price: $8.11 (as at Friday 11th March, 2011)
Lincoln Indicators (28/2/2011, share price was $8.46 that day)
Austock (20/12/2010, share price was $8.07 that day)
Patersons (15/11/2010, share price was $8.31 that day)
Alto Capital (29/11/2010, share price was $8.56 that day)
Chart: Share price over the year to 11/03/2011 versus ASX200 (XJO)
Surfwear and sports apparel company Billabong International recently announced its 2010 half-year results that beat analysts’ expectations. The company reported a profit of $57.2 million which was better than expectations of $54 million. Shares closed up .51 on a volatile trading session after the company’s announcement.
Yet despite the positive news from BBG, many analysts are negative on the retail sector as a whole and believe that some retailers will face significant difficulties over the coming quarters.
Investors who recently jumped on the wave of good news for BBG may find themselves left out at sea.
Billabong was formed in 1973 by current director Gordon Merchant and listed on the ASX in 2000. Billabong has a presence in more than 60 countries producing surfwear and sports apparel and accessories for the surf, skate and snowboard markets. The Billabong brand is targeted to both active participants in surf and extreme sports. Merchandise is sold under the Billabong, Element, Von Zipper, Honolua Surf Company, Kustom, Palmers Surf, Nixon, Xcel, Tigerlily, Sector 9, DaKine and RVCA brands. The majority of revenue is generated through wholly-owned operations in Australia, North America, Europe, Japan, New Zealand, South Africa and Brazil.
Weak Australian demand and the strong dollar pushed Billabong’s first-half net profit down 18 per cent in reported terms to $57.2 million from $63.4 million a year ago. Billabong Chief Executive Derek O’Neill said revenue would have been $49 million higher and net profit $6 million higher if not for the dollar’s strength. Including currency effects, the group’s six-month revenue of $834.9 million rose 16 per cent. CEO Derek O’Neill reaffirmed a prior forecast that group net profit for the year to June 30 would be flat in constant currency terms.
‘Thereafter, assuming global trading conditions gradually improve, in particular in the Australian consumer environment, the group expects to return to more historic earnings-per-share growth rates in excess of 10 per cent per annum in constant currency terms,’ Mr O’Neill said.
Looking at different segments of BBG’s business its apparent that the company’s performance in its Americas market was volatile and that it generated 49 per cent of first-half sales but just 30 per cent of earnings before interest, taxes, depreciation and amortisation. BBG’s America’s revenue rose 38 per cent in constant currency terms to $408 million, but its profit margin fell to 11 per cent from 14 per cent, partly due to its acquisition of Canadian retailer West 49. The Australasian market formed 32 per cent of sales but contributed 42 per cent of pre-tax profits. In Australasia, revenue rose 13 per cent to $269 million but profit margins fell to 19 per cent, from 28 per cent a year ago. The European segment contributed 18 per cent of sales.
Under O’Neill guidance, Billabong has implemented an acquisition strategy which has improved top line growth numbers but has come at the expense of the bottom line. Revenues increased as BBG increased the number of company-owned stores from 380 to 635 through acquisitions that included SDS/Jetty Surf and Rush Surf, but its consolidated EBITDA margin decreased by 5.8% to 11.3% (from 17.1%).
Management acknowledged that 2011 was part of a ‘transition year’ and improvement to the bottom line may not come for several quarters. Chief Executive O’Neill told analystS in a recent conference call: “The retail acquisitions have lumped a great deal of additional revenue into the business, but the revenue does not immediately filter through to create a stronger bottom line.”
One of the challenges of management’s acquisition strategy is that company has to work through the acquired inventory, which has lower margins than BBG is accustomed to. This basically means that Billabong must sell the inventory on the floor, the inventory in the warehouse and also the inventory on order by the previous owners before it can change the product mix on the floor and increase margins by the sale of company owned products to its own stores. Management anticipates that it have to get through one or two inventory turns of existing product from third party suppliers before it can start to realise the benefits of its strategy. Inventories rose approximately 31.17 per cent on prior corresponding basis. To fully integrate the recent acquisition, Mr. O’Neill said: “it usually took eight or nine months for the company to start realising the benefits of growth, as signage and buying economies of scale kicked in.”
Investment bank Credit Suisse recently commented that the major risk to BBG’s strategy is that ‘… earnings growth isn’t a guarantee”.
Here’s what others have said recently:
James Samson of Lincoln Indicators who has a sell recommendation said, “With weakened consumer sentiment already causing the company to decrease profit guidance in mid-December, we believe this sports apparel company is in for a tough time. Given the stock trades on a price/earnings ratio about 14 times in a difficult industry, we may see a further de-rating of the company’s shares in the future. The harsh reaction to recent retail disappointments from Myer Holdings (MYR) and The Reject Shop (TRS) may be indicative of how investors view results”.
Austock’s Michael Heffernan, who also has a sell recommendation, wrote that the “company is generating a substantial amount of its revenue in the US. As a result, a strong Australian dollar has reduced profits and the company share price. The company continues to face headwinds due to the strong Aussie dollar, which will pressure future short-term profit growth.”
Macquarie Bank downgraded BBG to neutral, citing its current valuation.
Better than expected earnings were not good enough for BBG to break out of its eight-month trading range.
A quick glance of the Billabong’s chart doesn’t exactly get your pulse running in antipation of quick profits. BBG shares have been stuck in an eighth month trading range between 7.40 to 9.15 with no clear signs that a break out will occur in either direction anytime soon. Not the kind of chart that will attract momentum traders.
Things will only begin to look more interesting if traders see demand starting to absorb the current supply being offered at the 9.15 level.
Investors who have taken solace in the latest announcement from BBG, may be disappointed in the near future. To be successful, Billabong management must execute its business plan in a poor retail environment that’s expected to continue; cope with rising input costs (i.e. cotton prices), a strong dollar, and continue to work through low margin inventory for the next few quarters. Factoring it all in, investors might be better off committing their hard-earned capital elsewhere.
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