Australia | Feb 25 2013
-Further guidance downgrades
-Profitability still weak
-Will the suitors' enthusiasm wane?
-Debt issues remain
By Eva Brocklehurst
The pressure is truly on Billabong International ((BBG)). The half year results came with yet another downgrade to earnings estimates for FY13 and, as brokers rushed to incorporate the data, the picture painted was not pretty. The trouble is, the action clothing retailer faces challenges at the internal level as well as from the retail sector and the macro economy.
The revised earnings guidance is $74-85 million for FY13, compared with $85-92m previously. This reflects lower earnings from Nixon and poor European trading conditions. For JP Morgan, interim earnings were assisted by cost savings and further mask the underlying deterioration in revenue. In Macquarie's opinion the half year results are irrelevant because the banks are likely to become involved in the company, unless a white knight rides up quickly. There are potential suitors. The company has two in train and they are conducting due diligence.
One thing remains certain. Billabong has a debt covenant issue. To resolve it, the banks agreed to reclassify debt as non-current with a repayment date of July 2014 but this was done just to provide time to complete negotiations with the bidders. Macquarie would be surprised if the arrangement survives, unless a definitive bid ensues. The one positive to take from the results is that weakness may make the board more ready to cut a deal. Citi takes that view. The negative is the suitors may have lost their enthusiasm in the wake of the numbers.
Citi flags the large write-down of the brand Billabong, noting this is another indicator of weak profitability. The company acknowledged that brand Billabong has been an poor performer across the regions, even in core markets of Australia and the US. Moreover, sales trends are still murky. Citi notes the company may be able to close stores and cut costs but the sales and earnings outlook for Europe will influence the risk premium that potential bidders attach to the company. Credit Suisse concurs, noting the troubling aspects for a buyer are the constrained timeframe for a turnaround in the business. The retail legacy issues have become worse in Canada and this raises the cost of exiting that part of the business. On the positive side, Credit Suisse finds Rvca is performing well and presents value for a buyer. Moreover, that business would be bought at a time of cyclically low profits from Europe.
Macquarie notes the rate of deterioration in the top line seems to be accelerating with little evidence the company's transformation strategy is reducing costs faster than falling revenue is reducing profits. JP Morgan believes the transformation strategy is on track but there's a risk of impairment for intangible assets as previous carrying values were based on FY16 earnings from this strategy. Management refused, or was unable, to issue guidance for FY16. CIMB sums up the company's situation as a toss up between a successful bid and the need to raise capital and finds the latter not a pleasant thought.
Many brokers believe the company would be better off privatised. Further assessment of that likelihood will come in March, when due diligence should be done. Deutsche Bank suspects things will get real tough if a firm bid is not forthcoming but finds a major obstacle for such a bid in the deteriorating outlook. The stock is trading well above the broker's valuation but the potential for a bid prevents a Sell rating. Macquarie sticks with a Hold rating, noting the equity value now appears to be worth no more than a $1.10 per share (indicative bid) and perhaps less than discounted cash flow valuation.
The number of Buy ratings on the FNArena database is one – Credit Suisse. The broker highlights the large difference between target price of $1.10, set on the basis of a bid, and a discounted cash flow valuation of 46c a share, set on the basis of the existing profit trend. There are five brokers rating Hold on the database and the primary reason is they have set their judgment aside, awaiting the potential bid. There are two Sell recommendations – BA-Merrill Lynch and UBS. UBS just doesn't believe the stock is compelling value at current levels and has moved to a price target of 80c. The range of price targets on the FNArena database is 65c to $1.10 and the consensus target of 88c reflects 3.6% upside to Friday's closing share price.
Should a takeover not proceed, Citi expects Billabong's share price to fall to between 62c and 83c, which reflects the broker's valuation range. The balance sheet may be stretched, but the broker expects an asset sale or more structured debt and working capital are the options if banking facilities cannot be rolled over in 2014. Citi places a 45% probability on a takeover deal proceeding. Credit Suisse is a bit more confident, but assesses there a lower chance of an offer emerging at the $1.10 indicative bid price than was the case ahead of the result. The broker still thinks a bid has a better than 50/50 chance of proceeding.
See also, Billabong Between A Rock And A Hard Place on December 20 2012.
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