Billabong’s Earnings Wipeout

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By Chris Shaw

Having been something of a market darling for some time the tide now appears to have turned for retailer Billabong ((BBG)), the company yesterday revising down earnings guidance to reflect weak markets generally and particular weakness in its US sales.

At the same time, the company announced a 2-for-11 issue at $7.50 per share to raise up to $290 million, which when combined with the revision to earnings guidance has seen brokers across the market rush to cut earnings per share estimates, not only for FY09 but in coming years as well.

The response from brokers hasn’t stopped there as the FNArena database now shows the company has joined the likes of Ten Network ((TEN)), Leighton Holdings ((LEI)) and Perpetual ((PPT)) at the bottom of sentiment rankings with a reading on the FNArena Sentiment Indicator of minus 0.6 (-1.0 is the lowest possible reading). The low sentiment rating is the result of recommendation downgrades overnight to Sell from Hold or Buy by four of the brokers to cover the stock.

Post the changes, the stock is now rated as Sell five times, Hold four times and Buy just once, though this rating comes courtesy of GSJB Were and has yet to be updated for news of the issue or cut to earnings guidance and so should be treated with caution.

In terms of actual numbers, management is now guiding to FY09 earnings of $160-$165 million, which compares to a previous market consensus of something in the order of $188 million. Add in a further 10% cut in earnings per share (EPS) terms to account for the capital raising and the endresult is for significant drops in forecasts. Macquarie has lowered its FY09 number by 12.3% and taking more than 20% from both its FY10 and FY11 estimates and Citi dropped its FY10 number by 21%.

Consensus EPS forecasts according to the FNArena database now stand at 77.2c this year and 76c in FY10, well down from the better than 85c per share achieved in FY08. Given the EPS changes the average price target is now $9.03, an improvement from $8.57 previously thanks largely to Deutsche Bank and JP Morgan lifting targets that were simply too low, while both Citi and Credit Suisse have lowered what have be proven to be overly optimistic targets.

In terms of the investment case for the shares, RBS Australia is one to downgrade to a Sell, arguing while there is longer-term upside the current issues the company faces mean its existing premium to the market is simply not justified. These issues include an emerging lack of visibility in terms of the near-term earnings outlook, a sentiment echoed by Bank of America-Merrill Lynch as it points out the downgrade has come just six weeks from the end of the financial year. This suggests the causes of the downgrade are quite severe and cause for concern in its view.

Citi agrees the earnings outlook has become much more clouded in the US in particular, while pointing out such a trend is likely to flow through to the company’s European and Australian operations as well in FY10. This suggests no quick recovery in the share price is likely.

Macquarie agrees, pointing out management has indicated hope for flat earnings in FY10, which is a far cry from the previous assumptions of earnings growth of around 15% annually. As this raises some longer-term questions the broker has had no hesitation in downgrading to Underperform from Outperform.

According to JP Morgan the big issue for the company is retailers are now shifting towards tighter inventory management, which means the normal early orders are being replaced by smaller and later orders. The challenge for Billabong in the broker’s view is it has taken the choice to defend its premium position in the market by not discounting its lines, a move that is costing it market share at present.

While a return to previous conditions is expected sometime in the future, the timing of such an outcome remains uncertain and is by no means guaranteed, supporting the broker’s view the stock shouldn’t trade at a premium until there is evidence of a recovery in market conditions.

Having said that, the broker recommends shareholders take up their entitlements in the issue as the company still has a strong medium-term earnings growth profile.

Shares in Billabong remain suspended but trading is expected to resume tomorrow. Prior to the suspension the stock last traded at $10.62, while its trading range over the past year has been $6.09 to $14.16.

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