Small Caps | Sep 01 2015
-Dilutes Oz exposure
-Doubling of earnings forecast
-Scope for higher margins
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By Eva Brocklehurst
Surfstitch ((SRF)), an online sports wear merchant, is confident that integrating several acquisitions onto one platform will pay off with improved market share and profile. After consolidating European business into Surfdome, from Surfstitch Europe, the company will now consolidate its assets into one global website under the Swell brand.
Surfstitch aims to become a worldwide online destination for action sports, offering its customers apparel, technology and travel products. Brokers welcome the strategy to re-brand as it should increase engagement and reduce duplication costs. The exposure to global demand is also welcomed as it dilutes the impact of a depreciating Australian dollar and slower growth in Australia.
The company has been busy in the US in re-setting its inventory since acquiring Swell.com from Billabong International ((BBG)). While growth in FY15 in that region was weakest, at 5.5%, the business is now considered better positioned as margins improve in the shift from discounted Billabong product. JP Morgan expects the re-branding to Swell should generate capex synergies by FY17 amid savings from improved scale in product sourcing and marketing benefits.
Gross margins improved in FY15 to 46.0% from 42.5%, attributable to improved terms, higher average selling prices and better merchandising. JP Morgan observes selling prices have benefitted from a larger proportion of hard goods. In Europe, the company has moved more towards action sports and away from lifestyle and outdoor products.The broker lifts its target to $2.40 from $2.10 and maintains an Overweight rating.
Outside of North America, Asia Pacific was a strong performer, with 43.4% growth in sales, despite the challenges in retailing domestically. Revenue growth in Europe was weaker, at around 18.6%. Margins improved, however, as Surfstitch Europe was consolidated into Surfdome. Further benefit is expected in FY16 as the business can leverage the simplified platform. From here, moving to single eCommerce brand should drive further upside.
Pro-forma sales were in line with prospectus, although only after a translation benefit from the weaker Australian dollar, Morgan Stanley observes. Nevertheless, sales growth remains at a level that does not provoke undue concern. The broker is looking for a clean set of numbers in FY16, as pro-forma and statutory accounts for FY15 show wide variance owing to the consolidation of the brands and acquisitions.
The clear path outlined by the company, and the apparent confidence in guiding to earnings of $15-18m – more than double FY15 – means the broker is confident the outperformance can continue. By having a very specific target market and offering a full range the company is differentiated from other online retailers. Moving to a single eCommerce brand under Swell should drive further upside and Morgan Stanley retains an Overweight rating and $2.25 target.
Bell Potter also has a $2.25 target with a Buy rating. The integration of all assets into one online global sports wear brand should deliver the expected synergies in FY17. The broker expects a 3-year compound revenue growth rate of 33%. Additional investment in marketing and IT infrastructure should underpin this growth.
The broker considered the FY15 results a positive outcome, given the company did not own Surfdome and Swell for the whole period. Importantly, in terms of the Australasian business, gross profit margins increased over 200 basis points. Similarly, in the UK, which accounts for 75% of the European segment, gross profit margins benefitted from the company taking control of the Surfdome business.
Bell Potter is encouraged by the re-positioning of the US brand and product offering and momentum is expected to build now the inventory restructuring is being finalised.The broker envisages scope for higher margins in the medium term because Surfstitch is less exposed to fast fashion and, therefore, price deflation. Moreover, this should be easier with global operations as inventory and currency fluctuations are managed more effectively.
Surfstitch is Australia’s largest online retailer and the world’s largest in terms of action sports and youth apparel. It acquired online action sports retailer, Surfdome, in Europe as part of its IPO. The company manages a retail platform that offers over 900 brands.
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