Written in the cards

  • Opinion
  • October 16, 2015
  • Warren Head
Written in the cards
Image: Kerryn Smith

There was growth across the four core retail sectors. Yet, the forward pack represented by street retail continues to get a rough time. Apparel, always a key sector for the retail economy, remains the weakest sector.

Hospitality growth slowed from recent highs, with the volatile weather an obvious factor, yet it remains the strongest core retail sector.

Nevertheless, when thermometers plunge as deeply as they have this winter, there had to be an opposite reaction and, after a flat trading period in May, we saw apparel outperform trend during June.

The difference between 2015 and 2014 winter season is snow in many regions.  As we move forward, it is more likely the weather effect will be supplanted by economic influences. The sustained decline of dairy milk prices will induce spending caution in rural New Zealand.

Already the cash flow boost in the opening quarter of the year from the fall in petrol prices has tapered off. Market analysts expect housing categories and hospitality likely to continue to outperform, while we expect apparel to remain challenging with low growth.

The timing of Briscoe Group’s takeover offer for adventure apparel and outdoor equipment retailer Kathmandu coincided with the arrival of the latter’s new chief executive.

Xavier Simonet was hardly 48 hours into the job when he copped Briscoe’s broadside. The business had been led by Mark Todd, as acting CEO, since the previous CEO, the formidable Peter Halkett, left to go sail the globe. Todd has returned to the role of CFO.

For his part, Rod Duke, the brilliant strategist at the helm of Briscoe Group (and its 80 percent majority shareholder), has proven over and again the importance of buying well. The takeover bid that Briscoe delivered was a very conservative mix of cash and scrip.

Simonet immediately looked ready to the challenge of denying Briscoe’s aspirations to add a major brand to its existing portfolio. He explained on his arrival that the potential for further growth at Kathmandu is strong, particularly internationally. The French-born executive will run the business from Melbourne, where he has relocated after two years running bag company Radley in the UK.

He has some 20 years of experience in fashion and cosmetics, including 11 years with luxury brand LVMH.

It was interesting that he quickly highlighted Kathmandu’s Summit Club loyalty programme which as 1.4 million members. He saw this as "an immense asset".

"I think what we've done a lot is around promotion and activities and it's good, it's part of the DNA of the company to give value to the customers,” he told a Fairfax reporter. “But I think we could leverage the brand equity much more to make it more inspirational and more distinctive."

"It's all about value but in a different way and not just about driving promotions all the time.” Isn’t that how many shoppers see Kathmandu?

The outcome of the takeover will probably now depend on how Kathmandu’s shareholders perceive the value of the Briscoe bid and, secondly (because money generally talks louder than loyalty) how quickly Kathmandu can turn its fortunes around from a rather sluggish first half-year.

Both companies have achieved strong momentum in revenue and gross profit by programmes of store roll-outs and by regular sales promotions. The footprint expansion is expensive in retail fit-out and marketing. 

Briscoe aims to acquire all of the ordinary shares of Kathmandu for a total consideration of $1.80 per share. Briscoe had considerable funds at its disposal to launch a bid and for years the retail sector has wondered just what would take Duke’s fancy. Not much in recent years. Yet with no long term debt and by mid 2015, almost $90 million at bank as a war chest, it would always be a major move. Having worked hard to achieve that position, Duke was never going to use all of the head room his resources presented.

If the bid succeeds, the combined group may have pro-forma debt of some $97 million. It would also create an Australasian retail group with revenue of ~$900m and wide product diversity.

 The offer is 88 percent scrip-based, with Kathmandu shareholders receiving five Briscoe shares for every nine Kathmandu shares, plus $0.20 cash per share.

Analysts have been sceptical. Forsyth Barr’s retail analyst, Chelsea Leadbetter, said, “We see limited synergy benefits between the two retailers and believe it is an astute and opportunistic move by Briscoe at a time where Kathmandu’s share price has been under pressure.”

First NZ Capital probably summed up the general view that the mix could be sweeter. “In our view, BGR’s current offer does not include any control premium, nor take into account any synergies that it must be incorporating as part of its proposed offer,” they said. “As such, it would be naïve to assume that no further additional consideration (ideally in cash form) will be required in order to get any deal across the line.”

They were being polite. Others said the offer was opportunistic.

So what then for Kathmandu’s full year outlook?

The emerging view is that favourable weather coinciding with Kathmandu’s winter sale bodes well for second half earnings.

A further consideration, analysts say, is working capital management. This was the key highlight of Kathmandu’s first half. “Assuming this trend has continued into 2H15, the upshot should be less unnecessary discounting as at year end,” noted First NZ Capital.  “On the basis that both of these factors come into play during the latter part of 2H15, this could result in a better revenue/GP margin dynamic.” So they have upgraded their FY15 earnings forecasts by 24 percent. They have also revised FY16 and FY17 earnings by +11 percent and +10 percent, respectively.

The value of the offer is attractive to Briscoe shareholders. However, Forsyth Barr said their assessed intrinsic value for Kathmandu is materially ahead of the current proposed offer.

I noted last issue that Briscoe is notable for a sure-footed business strategy. It has been developing a new stock management system that is believed to have a quite positive impact. Will Briscoe now achieve a prize catch? It will rather depend on whether 2015 - a year remarkable for very different seasonal weather (and exceptionally cold this winter) – is seen as just an anomaly for Kathmandu. Under takeover law, Kathmandu will release a target company statement, which will provide an insight into expectations.

Pumpkin Patch’s new chief executive Luke Bunt, who was on the board, faces a real challenge to turn the business around but there are indications that the strategic changes made during Di Humphries’ time in charge are starting to work. However, currency factors will be unhelpful and the company has indicated 2016 is likely to produce financial results materially below 2015.

Once favourable hedging rolls off in 2016, there could be pressure on margins. Bunt’s financial expertise (he was CFO at The Warehouse for several years) is being engaged as we write as Pumpkin Patch is in the process of renegotiating its banking facilities.

Further indications that the market is tight in Australia came in the third quarter sales release by Michael Hill, when the company inferred the decline in Australia would put pressure on its full year result. Management is seeking to correct the downward trend. The footprint growth rate is below expectations and the emphasis appears to be more on positioning for the future. Retail analysts like the potential that the new Emma & Roe brand, and the American market present as long-term growth opportunities. The efforts being made on ecommerce investment are being viewed as defensive in nature. Meanwhile, the company is sticking with the strategy to position the group brand at the upper end of mid-range jewellery chains.

Leasing can take time in the fluid retail environment of Christchurch. The vacant area on the upper level of the Eastgate Shopping Centre has been unoccupied since the centre reopened following the Christchurch earthquakes. 

However, owners NPT Ltd have now got conditional agreements to lease this substantial area to Linwood Avenue Medical Centre which will relocate from its current site to a new Integrated Family Health Centre.  It makes sense to have such professional services follow the customer. A cluster of social services providers are to follow including Aviva, Barnardos, Family Help Trust, START, Red Cross and He Waka Tapu.  More retail is also planned.

This story was originally published in NZ Retail magazine issue 739, August / September 2015.

​ ​

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