By Richard Hemming
We're seeing what can go wrong for a retailer after last night's announcement by Oroton of expected flat profits and the loss of the prized Ralph Lauren Polo brand, which the market valued at about $100 million. Its shares lost as much as 25 per cent at the open this morning.
But does the 30 plus per cent share price spike in the past month or so for clothing maker Pacific Brands and adventure wear retailer Kathmandu mean that things are once again hunky dory for the two embattled small caps? Investors will hope so.
Under the Radar often proclaims the virtues of investing in the operational turnarounds, but in the Pacific Brands (PBG) case it is still very much a case of buyer beware.
The Australian owner of such brands as Bonds and Slazenger might have benefited from a property sale worth $27 million this week, but Radar thinks that the share price rise relates to the hope that private equity will come in and play the role of Mike the Knight for shareholders.
It's expected that the private equity group TPG will do exactly that for the embattled surf wear retailer, Billabong.
But at least one of the barbarians in the form of private equity group KKR has already walked away from takeover talks with Pacific Brands as recently as May. If TPG is successful in acquiring Billabong, does this mean that private equity will have a change of heart and take over Pacific Brands?
The trouble with Pacific Brands
At 60¢ the stock trades on a forecast PE of about 7 times, which suggests it is a bargain. Radar thinks that this is only the case if private equity steps in and sees value where others (including us) can't.
The underlying business is facing problems that far exceed its ability to flog properties. For one thing Pacific Brands is being “dis-intermediated”. This term doesn't come from George W. Bush, and refers to the trend of retailers going directly to manufacturing locations such as China and establishing their own brands.
Another problem is that its recently reduced catalogue of brands makes it less relevant to its retailer customer base. Plus, it's not spending as much on those brands as it did in the past, which reduces their value.
And all this is before mentioning its $215 million debt burden. As senior executives leave the ship, we would be very surprised if private equity came in to save the day.
Re-scaling the mountain
It's not all bad news in bricks and mortar retail land. Kathmandu (KMD) is on its way back after a disappointing first half result due to its sales being concentrated into very brief periods. About 95 per cent of the group's sales come from its big sales during Christmas, Easter and Winter. If one of these key periods is slow, you can forget about good profit results.
After a subdued result for its first half, or six months to January, analysts panicked and slashed their forecasts. This was premature because about 75 per cent of the company's profits come in the second half just gone.
Added to this is it was particularly cold last winter and people buy Kathmandu's fleeces in cold wet weather. Plus, the cash stimulus from the carbon tax rebates should also boost Kathmandu's coffers.
At $1.33 a share, Kathmandu trades on a forecast PE of about 9.5 times, well below the industrial average of close to 13 times. We think this one will keep climbing.
Online retailers seem to be doing it easy
There are some retailers that have never been in struggle street. These are of the online variety. Webjet's shares are up about 30 per cent in the past month. The hotel and flights booking provider increased its profits about 25 per cent and delivered big dividends to match. REA, owner of realestate.com.au delivered a result of similar magnitude yesterday. Chris Prunty, a small cap fund manager with Ausbil, explains the attraction for shareholders: “They keep growing their free cash flow and paying out big dividends, which is nirvana for investors.”
The PE for the privilege of owning these companies is about 20 times future earnings. There's no chance that they are going to get re-rated, so if they don't keep doing the business of 25 per cent earnings growth, watch out!
This article is not intended as investment advice.
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