Australia | Oct 15 2015
-Margin expansion potential
-Early success in turnaround
-Quiksilver problems an opportunity?
By Eva Brocklehurst
Surfwear and accessory manufacturer Billabong International ((BBG)) has triggered interest at Canaccord Genuity, with expectations there is a margin expansion story buried in the company's outlook. The broker believes recent investor presentations have put the stock back on the radar for investors and analysts and this could be a positive catalyst if the company's strategy continues to bear fruit.
Margin expansion provides the short term potential, as management implements a strategy of simplifying its supply chain and prioritising its brand. The expansion will come from improvements in sourcing and changes to logistics, as well as the roll out of the omni-channel distribution platform.
Improvements in sourcing have scope to drive 300 basis points of margin while distribution and logistics could add another 150 basis points, the broker contends. A reduction in the timeline from designer to market is also expected to cut waste and improve the company's response to trends. The brand structure is being rationalised with the intention to have fewer but larger brands. The big three will be Billabong, RVCA and Element.
The company's earnings margins increased to 6.2% in FY15 from 5.9% in FY14 and management has signalled a desire to return this to double digits in the next few years. Canaccord Genuity considers this eminently achievable. The broker also envisages upside risk to revenue forecasts as marketing efforts and merchandising strategies ramp up. Earnings estimates are based on a step up in margins to 8.6% in FY16.
The management team has limited interaction with investors, usually, outside of the regular half year and full year briefings. Since the FY15 result management has actively engaged with investors in presentations and has signalled it believes internal change will be the driver of earnings growth rather than general industry trends or factors outside of its control.
Canaccord Genuity hails the intense focus on implementing the turnaround and the success with the early stages. The broker envisages some upside risk to revenue growth forecasts for the US and European operations, which should provide additional earnings leverage.
Existing high cost debt facilities could be refinanced in FY18, the broker believes, despite an apparent early repayment charge which appears expensive. The broker understands this charge drops significantly after November this year, to 6.0% from 11.0%, and continues to decline throughout the remainder of the four-year term. Additional benefits which would come from repaying the loan early include the ability to sell assets, pay dividends or undertake other capital restructuring.
Three is another aspect to the broker's confidence. Competitor Quiksilver has recently filed for Chapter 11 bankruptcy protection in the US to allow it to restructure its property portfolio and refinance its balance sheet. While not commenting on this situation, Canaccord Genuity does suspect this could provide Billabong with an opportunity to take market share from one of its largest competitors.
The broker, not one of the eight monitored daily on the FNArena database, initiates coverage of the stock with a Buy rating and 90c target. The target is based on an enterprise value/earnings multiple of 10.7 on FY16 estimates. A two-year valuation based on the same multiple for FY17 is $1.14, representing 69% upside from the current share price.
Brokers on FNArena's database appear much more circumspect. Last month JP Morgan flagged a suspicion that the retail environment in the US had worsened. The broker does not deem the risk/reward compelling enough and pulled back its rating on Billabong to Neutral at the time.
Deutsche Bank also suspected, in the wake of the FY15 results, that the benefits of a turnaround are fully priced in and the outlook remains challenging. There are three Hold ratings on the database with a consensus target of 68c, suggesting 0.2% downside to the last share price. Targets range from 65c (Deutsche Bank) to 70c (Citi and JP Morgan).
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