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Dumped by the wave of Fashion

Value.able | Comments (10)

Dumped by the wave of Fashion

There was a lot of surfing on the Montgomery annual holiday so I thought I’d publish these thoughts on Billabong International for you.  Happy new year and all the best for 2012.

Billabong’s trading update in December attracted a great deal of attention – not only from shareholders who rushed the exits to sell their shares, but also from commentators who noted the result was a symptom of a cyclical and structural shift in the way retail goods, particularly fashion, is bought and sold in Australia.

That Billabong had downgraded its earnings guidance should not have come as a surprise: it is not the first time it has done this. In 2009-10, it announced a series of downgrades then failed to even meet the lowered figure in its full-year result. In 2010-11, it announced downgrades in October and December, then again in March 2011. Billabong is not a stranger to downgrades.

But downgrades aren’t the only reason I have never bought shares in this company. On a number of measures it has failed to live up to the high standards I set for a candidate to enter and remain in an A1 portfolio. On some of those measures it may be argued that Billabong has a “challenging road” ahead – a euphemism for the possibility of a serious structural change, which may include a capital raising, asset sales and/or write-downs.

Retailing in Australia has been doing it tough and I have written previously about the perfect storm facing conventional bricks and mortar retailers in this country.

Another retailer, JB Hi-Fi (ASX: JBH, SQR A3, $12.50), had been 5% of the Montgomery [Private] Fund portfolio until we sold out at $15.50. Our reasoning was simple: given present circumstances (the strong dollar and strong outbound tourism, and the consumer shift to online buying) and expectations for retailing (having spoken to many retailers recently), many retailers would have to revise their earlier outlook statements and this would produce lower future valuations.

Notwithstanding today’s speculation that the announced sale of Dick Smiths by Woolworths (ASX: WOW, Skaffold Quality Score B2, $24.45) will trigger a bid by the grocer for JB Hi-Fi, analysts’ forecasts are typically optimistic in the first half of the financial year (this year being no exception to that rule) and we should therefore be demanding much larger discounts and JB Hi-Fi’s shares were not offering that margin of safety.

I have also noted before that the deflation story – as explained by Gerry Harvey, who says selling plasma TVs for $399 last year means he has to sell three times the volume as last year to make the same money – would put pressure on profits because people already had enough plasma TVs.

Finally, we also believe ANZ’s reported profit growth last year, being dominated as it was by bad debt provisioning writebacks, meant that credit growth was non-existent. When you take away growth in credit card purchases that’s got to hurt discretionary retailers.

Billabong cannot be immune. And a long-winded, multipage analysis of the issues plaguing this company is not required because we’ve never suggested it as an investment.

Billabong reported that its first-half EBITDA in constant currency terms would be $4 million higher, but the company is a global retailer and its reported EBITDA is expected to be 20.8% to 26% lower. The company added that strong growth in constant currency terms in 2012 “is not expected”.

Tellingly, the company also noted that a full strategic review is required and a capital raising cannot be ruled out. The reason for this is simple: in light of deteriorating trading conditions the company has bitten off more than it can chew. This is best seen in the cash flow statement.

In 2010-11 Billabong reported profits of $119 million but cash flow from operations of just $24 million. Subtract dividends of $78 million (why pay dividends if you don’t have the cash?) and capex and investments of $266 million and you have a deficit that needs to be plugged with an equity raising or debt.

Turning to the balance sheet, you will find goodwill amounts to about $1.3 billion. That’s $1.3 billion of “oops-I-paid-too-much” and is more than half of the assets of the company. There’s also borrowings of $600 million and, despite the boost, the company is currently forecast to earn a return on equity of just 7%.

Given my bank is offering 90-day term deposits at 5.95%, I wonder how Billabong’s auditors can justify the carrying value of the goodwill on the balance sheet.

So there are two pretty good reasons you haven’t seen Billabong mentioned as a company to conduct more research on this year – or any year, for that matter.

Investing in 2012 could be largely about avoiding losses. To do that, you will need to watch out for companies whose structures are weak, whose performance is undesirable or whose price is too high. Obviously any stock that harbours all three conditions does not require my comment here.

Billabong’s debt has been rising, its return on equity falling, its balance sheet weakening and as an A4 on Skaffold’s quality scale, it was not investment-grade.

Skaffold’s Quality Score History for Billabong


If you are thinking about investing in retail in the coming year, be sure you know what to look for, even if mouth-watering prices are being offered.

Finally, for Skaffold member’s I hope you enjoy update 1.1 you will be receiving today, making Skaffold even more powerful and user friendly.  If you are not a member of Skaffold, what are you waiting for?  Skaffold is the best way we know of to deal with the market’s main risks;

Don’t miss an opportunity – every stock is covered and updated daily and automatically.

Reduce the risk of paying a high price for a stock – Skaffold’s intrinsic values ten years back and three years forward for every company.

Reduce the risk of buying the wrong company and suffering permanent capital loss – Skaffold’s Quality Scores, cash flow information and projected intrinisic values are updated in real time, keeping you abreast of vital changes to a company’s prospects as an investment candidate.

If you have been thinking about becoming a ‘Skaffolder’ there are few better times to get started than just before companies start releasing their important Half Year results.  Skaffold’s intrinsic values are updated live and daily so as company’s prospects are upgraded (or downgraded!) during reporting season, you are likely to find a multitude of opportunities for investigation.  Go to www.skaffold.com to get started just as reporting season takes off.

All the best for 2012.

Posted by Roger Montgomery, Value.able author and Fund Manager, 31 January 2012.


INVEST WITH MONTGOMERY

Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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10 Comments

  1. John C
    :

    Welcome back Roger! Good post on BBG. Turning to better structured companies for a minute – I note that Acrux (ACR) have received a “notice of allowance” for their Axiron applicator patent in the USA (expected expiry: July 2029) – this was one of the questions that you shared with us on the blog a few months back – whether or not they would be granted a patent for their applicator – which would have a reasonable impact on their future value. I know there are plenty of other factors to consider also, but it’s good news for ACR holders. I sold mine at $3.73 last August for a nice profit, but I’m still following them. I prefer Sirtex Medical (SRX) in the small-cap healthcare space currently.

    I have noticed a few really good opportunities have been popping up lately, and I have been topping up holdings (like RMS last Monday 23-Jan at 94 cents). Over the past few days, I’ve seen some good positive movement in a lot of “value” stocks; I was pleased with BRG’s trading update today (& 6% rise in SP), and I also note ZGL moved up by 12.7% on no news – and GL Sim has been buying shares again. Breville (BRG) seems to be a very well managed company in a tough space that are doing all right. It’s a stock-picker’s market – it doesn’t pay to play sectors in this market. Your post clearly highlights some of the warning signs that should clearly tell us to avoid a company like Billabong (BBG). There are plenty of others though (like BRG) that are doing most thing right, luckily.

      • John C
        :

        Re – my comment above about ZGL moving up 12.7% on no news – the ASX noticed too, and issued them with a “please explain”. They explained alright… but not giving any reason for the rise – just reasons for a 32% fall today. They closed today down 20% (approx.) from where they were at the start of the week, so that’s not as bad as looking at today’s fall in isolation, but it’s bad enough. On the other hand, it’s short term SP movement, not a change in the underlying value. I’m holding, not selling. However, I’m not buying any more either. I already hold enough – I prefer to stay reasonably diversified, by company and sector. If Zicom’s 3 start-ups do as well as they expect, and if they are painting a true picture of the state of their main divisions (in their profit warning announcement today), then I think they’ll be fine in a couple of years. We’ll see. In the meantime, their SP will probably slide further south.

      • John C
        :

        I’m not surprised John. You said a while back that my ZGL “investment” (you did use quotes, so I assume you don’t regard them as investment grade) would end in tears. No tears from me yet. I changed my mind yet again and yesterday bought another 50,000 at $0.185. I hope I’ve not fallen in love with this company – I’ve tried to keep emotion out of my decision making, but the more I look at them, the more I see value at these prices. It may well end in tears, but not for another couple of years at least. They’re not going to go bust in that time with their current low debt levels, and I’m still bullish on their long term prospects.

        I can see why my views on ZGL might remind some people of those who continue to hold MCE and are still waiting on the recovery in their order book and SP, and I certainly can see some similarities there. I prefer ZGL to MCE because of their more diversified revenue base, and I lost a lot of respect for MCE management around what I saw as an opportunistic capital raising at a high price when I believe they would have to have been aware of the order book issues and that the high SP could not be sustained at the capital raising price (or above) due to their declining cash flow and lack of forward orders. I therefore believe that the shareholders were not kept adequately informed of all available information that could have affected their individual decisions to participate (or not) in that capital raising (at that high price). Basically, a matter of trust. I don’t think MCE management acted in the best interests of their everday shareholders, and I don’t trust them. I still have trust in the management of ZGL. That’s the difference for me.

  2. Andrew
    :

    Hi Roger, feel free to delete this if you want as it isn’t really relevant to the above except for a look into what 2012 might have in store.

    I have read with interest the news that Facebook might be launching their IPO soon. These rumours have been around before so who knows if it will happen. They will list at some point but who knows when.

    The reports are that the IPO will “value” the business with a market cap between $75-100 billion.

    My first reaction was to sit back and scoff at that figure, but as a curious fellow i decided to see what i can find.

    First i will admit a certain type of bias in that in undertaking this exercise i expected to be proved right that facebook will list at a price that overvalues the company by a rather big margin so take the below with as many grains of salt as you will like.

    According to various news figures facebook revenue for 2011 was $3.8 billion meaning that it will be on the market on a price to sales ratiio of somewhere between 19x and 26x.

    From various reports about previous years results it appears they have a net margin of around 26%. The latest report i have read from Forbes mentioned profit of $1.5 billion but using the 26% figure i get around $1 billion so lets average it out to $1.25 billion.

    This means the company could be listed on a price to earnings ratio between 60x to over 100x.

    It will be interesting to see what hard data that comes out so i can actually attempt come up with an intrinsic value rather than the crude P/E ratios but so far it is unsurprisingly to me, appears to be very expensive.

    Maybe some are just very optimistic about the future but i am not sure how much further facebook can go or how big it can get? I could and probably am completley wrong. But i will make a prediction that this will be the biggest investment story of the year if it does happen.

  3. Andrew
    :

    Welcome back Roger, very interesting post to start the year.

    I have to agree with your views on this company. There is not much that i have seen that would ever warrant me making an investment in whether i am looking backward or forward. The cashflow as you mentioned is a big worry.

    As for the retail sector, i think it is going to be a difficult time for discretionary retailers. Trips to the local shopping centre show exactly what is happening and i think any company that doesn’t fit into the luxury or lower end retailing and are instead sandwiched in between are in for a very tough year. I would class both Myer and Billabong in this.

    For anyone who is interested in retail stocks, i really encourage to go out and realyl pay attention to what stores are busy (particularly at the registers) and which ones aren’t. It paints an interesting picture.

    Without a big increase in sentiment allowing people to open up their wallets again, i can’t see any listed retailer exceeding expectations and probably a few falling below or issuing downgrades. That isn’t to say that there are no quality companies in this space, and it is possible some good opportunities will arise for those who have a long term investment time frame.

    I do completley agree with your comment that investing in 2012 might be a case of avoiding losses. It will be an interesting year.

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