Australia | Jun 22 2012
– Billabong announces dilutive capital raising
– Proceeds to reduce debt
– Earnings guidance also cut
– Brokers expect the stock will remain under pressure
By Chris Shaw
The ongoing balance sheet pressures being experienced by Billabong ((BBG)) thanks to continued weak trading conditions in a number of markets have forced the hand of management, with the company yesterday announcing a highly dilutive capital raising.
The issue will be a six for seven pro-rata entitlement offer at $1.02 per share to raise around $225 million, with the proceeds to be used to repay group debt. Group debt should fall to around $100 million post the issue, which is fully underwritten.
The issue appears to be the result of a further deterioration in trading conditions in the view of BA Merrill Lynch and has been somewhat rushed in the view of JP Morgan. This reflects the lack of any accompanying detail with respect to a transformation program for Billabong in coming years. A basic outline has been offered that includes reducing the complexity of the business, increasing brand focus and centralising systems, but much work needs to be done in Citi's view.
At the same time as the issue was announced management has lowered earnings guidance for Billabong and for FY12 this means previous EBITDA (earnings before interest, tax, depreciation and amortisation) guidance of a result of around $157 million has been cut to a result of $130-$135 million.
In FY13 the expectation is earnings will be in excess of pro-forma results for FY12, assuming no further deterioration in trading conditions. JP Morgan expects the current softness in trading will continue into FY13.
The revised earnings guidance from Billabong was well below market forecasts and brokers have been quick to respond by cutting estimates for the company. The changes also reflect the impact of the capital raising.
In Citi's view the clearing of the decks by the new management team at Billabong will result in cuts to consensus earnings estimates of 50% or more in FY13, while RBS Australia estimates the capital raising will dilute FY13 earnings by around 46%.
While taking the view the dilutive capital raising was not the best way for balance sheet concerns to be addressed, RBS suggests the future for Billabong will at least be boosted by a much stronger balance sheet. This should provide management with the flexibility to make the necessary changes to the business.
In RBS's view Billabong is no longer a top-line growth business, meaning the focus should shift to operational efficiencies. Valuation should be related to well capitalised, vertically integrated brand owners and RBS notes similar global peers are trading on an average one year forward earnings multiple of around 16.7 times at present.
Based on the new earnings estimates of RBS, which in earnings per share (EPS) terms are 16.3c this year and 13.9c in FY13, the stock would be trading on an undemanding FY13 multiple of around 10.5 times. As a basis for comparison, RBS's new EPS forecasts compare to the normalised EPS forecasts of JP Morgan of 15.3c and 10.7c respectively.
While not appearing expensive, Citi suggests Billabong shares are likely to remain under pressure near-term given the sales and profit outlook remains cloudy. This puts some pressure on management to show early signs of fixing the brands and stores in the broker's view and sees a Neutral rating retained.
JP Morgan also expects Billabong shares will struggle, given continued exposure to poor macro conditions, execution risk with respect to the transformation strategy to be put in place and ongoing questions about future sales and margins.
Given this, JP Morgan retains an Underweight rating on the stock with a price target of $1.20, down from $1.89. BA-ML has cut its target to $0.85 from $1.50, while retaining an Underperform rating.
Credit Suisse has seriously taken the knife to its forecasts, dropping its target price to a mere 41c from $2.50 with an accompanying downgrade to Underperform. "In our view," says Credit Suisse, "Billabong is a high risk investment and probably not suitable fro mainstream investors". The analysts cite the company's poor record in predicting earnings, a long term decline in brand earnings, and a long period of restructuring with likely further changes ahead as reasons for its negative view.
Noting FY12 earnings guidance has fallen $25m since the last update in February, CS suggests were BBG to lose a further $30m in earnings across the forecast horizon (FY12-14) — a quite feasible possibility in the broker's view given recent unpredictability — all equity would be eliminated in the broker's valuation.
RBS is far more positive longer-term, seeing potential for new management to deliver operational improvement over time. This implies value at current levels sufficient to justify a Buy rating. RBS's target declines to $1.85 from $2.45.
Overall the FNArena database shows Billabong is rated as Buy twice, Hold three times and Sell three times, with UBS (Buy) yet to update its forecast. The consensus target in the database is $1.68, but aforementioned "unpredictability" is reflected in a range of targets from Credit Suisse's 41c to Citi's $2.80.
One for the brave.
Shares in Billabong are currently suspended, having last traded at $1.83. This compares to a trading range over the past year of $1.70 to $6.42.
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