AUSTRALIA BBG AU Price (at 06:10, 27 Aug 2012 GMT) A$1.35 Volatility index Very High GICS sector Consumer Durables & Apparel Market cap A$m 644 30-day avg turnover A$m 4.4 Number shares on issue m 478.9 Investment fundamentals Year end 30 Jun 2012A 2013E 2014E 2015E Revenue m 1,550.7 1,345.7 1,346.4 1,374.9 EBIT m 52.6 74.9 90.6 91.0 Reported profit m -279.3 53.0 61.5 65.0 Adjusted profit m 33.5 53.0 61.5 65.0 Gross cashflow m 80.2 102.1 112.0 117.2 CFPS 24.9 27.9 23.5 24.6 CFPS growth % -49.9 11.7-15.7 4.6 PGCFPS x 5.4 4.8 5.7 5.5 PGCFPS rel x 0.62 0.66 0.86 0.86 EPS adj 10.4 14.5 12.9 13.6 EPS adj growth % -71.9 38.7-10.9 5.8 PER adj x 12.9 9.3 10.4 9.9 PER rel x 0.93 0.80 1.05 1.05 Total DPS 2.4 0.0 0.0 0.0 Total div yield % 1.8 0.0 0.0 0.0 Franking % 0 nmf nmf nmf ROA % 2.3 3.6 4.4 4.2 ROE % 3.0 5.0 5.5 5.5 EV/EBITDA x -2.8 6.5 5.7 5.6 Net debt/equity % 15.7 11.8 3.7-3.6 P/BV x 0.4 0.6 0.6 0.5 BBG AU vs Small Ordinaries Source: FactSet, Macquarie Research, August 2012 (all figures in AUD unless noted) 28 August 2012 Macquarie Securities (Australia) Limited Deep dives everywhere Event Billabong (BBG) reported a FY12 loss of $275.6m. Excluding significant items loss of $516.9m and profit on sale of discontinued business of $206m, FY12 NPAT was $33.5m compared to $119.1m in pcp. No final dividend was declared. We discuss. Impact At the group level, on a continuing business basis and before ISI s, reported revenue declined by 7.3%, EBITDA declined by 52% and NPAT declined by 63%. However, when measured on a continuing and discontinued basis, sales revenue declined by 7.9%, EBITDA decline by $84m (40.9%) and NPAT decline by 74.3%. The exact decline in contribution from company-owned retail was not disclosed but based on commentary from management that stand-alone retail would be break-even we estimate c. $50m of the $84m decline in EBITDA could be attributable to retail. Given the significant size of company-owned retail (c. $719m in sales in FY12) management addressed strategies to fix the business model in its inherent value presentation. While it appears to be a good sales document there was substance in new CEO Inman s assessment of the company s weakness in retail and opportunities to improve the business. In addition to closing an additional 82 stores in FY13 (operating 634 at June 2012) it was revealed that currently 20% of stores are loss-making and a further 20% are just covering their return on capital. Management are looking at ways to improve stores to lift them to the next tier of profitability via improved visual merchandising and high-impact, low-cost store touch ups. While they have shut stores where it was economic to do so, the remaining unprofitable stores they hope to lift profitability to a neutral ROC outcome. They also revealed that they have brought in Colin Haggerty (from Target Australia and extensive UK retail experience) to bolster Billabong s retail expertise. Management identified the earnings prize over the next three years as lifting EBITDA from $84m pro forma in FY12 to c$155m in FY16. Earnings upside is expected to be driven by modest revenue growth, cost and efficiency gains such as simplifying the business, globalising and integrating the supply chain and exiting uneconomical retail stores. Sales-led initiatives include leveraging of brands as well as building out the e-commerce platform into Europe. FY net cash flow from operating activities rose to $78m reflecting working capital releases compared to pcp. Earnings and target price revision FY13E, 14E and 15E EPS -12% and -7%, respectively. Price catalyst Due to research restrictions, Macquarie cannot advise its valuation on BBG AU at present. Action and recommendation Restricted. Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com/disclosures.
Analysis Billabong reported its FY12 results in three different formats. In the table below is the consolidated income statement on a continuing business basis per the Financial Report. The financials are presented as if Nixon (partial divestment and now an associate) were eliminated for the full year. What is interesting about this analysis is that the significant deterioration in EBIT has come from overheads associated with the retail business and not the trading line, eg, gross profit. However we do note an ISI of $73m was booked against the GP line in the accounts (we remove for comparative purposes) and it relates to inventory sold over FY12 and to be sold over FY13. Fig 1 FY12 P&L on a continuing business basis FY11 FY12 chg $ chg % Sales revenue $m 1558.5 1444.1-114.4-7.3% COGS $m 728.3 691.6-36.7-5.0% Gross profit $m 830.2 752.5-77.7-9.4% Other income $m 5.1 5.1-0.1-1.0% SG&A $m 564.7 527.6-37.0-6.6% Other expenses $m 144.8 195.9 51.2 35.4% Associates $m 0.3 0.3 EBIT $m 125.9 34.2-91.6-72.8% Finance costs $m 37.2 41.0 3.8 10.1% PBT $m 88.7-6.7-95.4-107.6% Tax expense $m -3.8-40.0-43.8 NPAT $m 92.5 34.3-58.3-63.0% ISIs $m -516.9-516.9 Discontinued business $m 25.5 206.0 180.5 non controlling interest $m 1.1 1.0-0.1 Reported NPAT $m 119.1-275.6-394.8-331.3% Ratios (%) chg $ chg bps COGS % 46.7% 47.9% - 46 GP margin % 53.3% 52.1% - 53 SG&A % 36.2% 36.5% - 36 EBIT margin % 8.1% 2.4% - 8 Effective tax Rate % 4.3% 593.4% 2 Depreciation $m 37.8 44.6 6.8 17.9% EBITDA $m 163.7 78.8-84.9-51.9% EBITDA margin % 10.5% 5.5% - 10 Source: BBG, Macquarie Research, August 2012 BBG also produced a group and regional profit and loss on a continuing and discontinued basis. On a reported basis sales revenue declined 7.9% to $1.55bn (-5.0% on a constant currency basis) and EBITDA declined 32% to $130m (constant currency EBITDA declined 30%). Adjusted EBITDA (before significant and exceptional items) in FY12 was $120m. The elimination of Nixon revenue an EBITDA across FY12 reduced sales revenue by $111.6m (FY11 $129m) and EBITDA by $36.2m (FY11 $42.6m). Around the regions, on a continuing and discontinued basis, revenue fell in all regions except Australia and EBITDA fell between 20% and 50% in all regions. The split between wholesale and regional performance is shown in a table below but not the rate of change across FY12. It would appear, however, based on disclosure in FY11, retail EBITDA has declined by c. $50m to a breakeven basis on a stand-alone measure, eg, sales of product from BBG wholesale to retail at full margin. This analysis doesn t necessarily mean BBG wholesale profitability is unchanged as we cannot be sure about the impact the ISI in FY12 COGS has had on either business. It is also an unusual entry how do you sell inventory below costs but create a debit to COGs? What do you credit? Goodwill? There is also an unknown positive impact on FY13 profit and loss as redundant old stock is liquidated and the provision released. 28 August 2012 2
Fig 2 FY12 P&L on a continuing and discontinuing basis Constant currency versus reported results FY11 FY12 chg $ chg % Constant currency Sales revenue $m 1,631.5 1,550.6-80.9-5.0% EBITDA $m 186.9 130.4-56.5-30.2% NPAT $m 115.9-275.6-391.5-337.8% EBITDA margin % 11.5% 8.4% Regional Sales Revenue FY11 FY12 chg $ chg % Americas $m 843.7 750.3-93.4-11.1% Europe $m 337.6 278.1-59.5-17.6% Australasia $m 501.9 522.3 20.4 4.1% Total sales revenue* $m 1,683.3 1,550.7-132.6-7.9% EBITDA $m Americas $m 80.2 59.7-20.5-25.6% Europe $m 54.2 24.2-30.0-55.4% Australasia $m 55.2 33.8-21.4-38.8% Other $m 2.2 2.9 0.7 31.2% Total EBITDA $m 191.8 120.6-71.2-37.1% Margins bps Americas % 9.5% 8.0% - 155 Europe % 16.1% 8.7% - 735 Australasia % 11.0% 6.5% - 453 Total EBITDA % 11.4% 7.8% - 362 *excludes 3rd party royalties Source: BBG. Macquarie Research, August 2012 BBG released a wholesale/retail split for the business for FY12. The eliminations adjustment reflects duplicated profit between the two businesses but what is not disclosed is how the amount is allocated. When queried CFO White acknowledged BBG retail would be break even or perhaps a small loss. Fig 3 BBG PL on a continuing and discontinuing basis split between wholesale and retail Wholesale Retail Eliminations Adjusted Consolidated Sales $m 1069.5 719.6-238.5 1550.6 EBITDA (pre-global costs) $m 199.9 65.1-104.1 160.9 EBITDA margin % 18.7% 9.0% 10.4% EBIT (pre-global costs) $m 180.6 40.0-104.1 116.5 EBIT Margin % 16.9% 5.6% 7.5% Global Costs $m 31.3 9.0 40.3 EBITDA (post-global costs) $m 168.6 56.1-104.1 120.6 EBITDA margin (post global costs) % 15.8% 7.8% 7.8% EBIT (post global costs) $m 149.0 30.9-104.1 75.8 EBIT margin (post global costs) % 13.9% 4.3% 4.9% Source: BBG, Macquarie Research, August 2012 Transformation strategy diving deep Management presented the findings from their two-month review of the business and the plans to stabilise Billabong s earnings and return it to growth. First in identifying the prize, management estimated the market size (in Fig 4) of the global boardsports retail market at c$15bn, of which BBG share is c.15%. Growth in this segment of the market over 2009 to 2012 was estimated to have grown c.4% compounded annually. Management also identified the earnings prize over the next three years as c$155m+ of incremental EBITDA as shown in Fig 5. Many of the items identified are cost and efficiency gains such as simplifying the business, globalising and integrating the supply chain and exiting uneconomical retail stores. The sales-led initiatives are leveraging of brands as well as building out the e-commerce platform into Europe. 28 August 2012 3
Fig 4 Serving a c.$15bn boardsports market Fig 5 Targeting $155m of incremental EBITDA by FY16 Source: Company slides, Macquarie Research, August 2012 Source: Company slides, Macquarie Research, August 2012 Management s study has also concluded that Brand Billabong currently only serves ~19% of the boardsport market (Board Sports participants and Board Sports fanatics). They are missing c.34% of the market (being the Active Lifestyle) who have the same mindset as the core Billabong customer, however, do not have the time or frequency of participation. Therefore, management believes they can target 53% (i.e., a further 34%) of consumers without impacting the core customer through loss of brand authenticity. Trade feedback from boardsports store owners has been that just c.10% of customers are participants and the rest are not, thus BBG is already serving that market. Further, Brand Billabong was shown to have high brand awareness (86% in Australia, although just 47% in USA) although management were not happy with the conversion i.e., only 39% of Australians and 29% of Americans who are aware of the brand actually made a purchase in the last twelve months. Other brands such as Element, Dakine and RVCA had conversions rating between 40-50% that management were pleased with. Based on these metrics, Australia s conversion doesn t appear unreasonable and realistically it is just Brand Billabong s conversion in the USA that falls short. Fig 6 Billabong to target 53% of consumers Fig 7 High Billabong awareness, low conversion Source: Company slides, Macquarie Research, August 2012 Source: Company slides, Macquarie Research, August 2012 Quick wins within the next few years involve a simplification of the business with management expecting to add an incremental c$10m. These initiatives involve identifying a tail of styles, suppliers and customers that add cost and complexity to the business but do not make a meaningful contribution to sales. Examples were given that 46% of suppliers represent just 1% of purchases, 33% of customers represent just 1% of sales and 34% of styles represent just 1% of sales. 28 August 2012 4
Management indicated that they will reduce their style range by c.15% in FY13 and a further 15% in FY14. We wonder if a reduction in range will impact the brands, drive a mass market perception and have less niche product to offer to maintain brand authenticity. Fig 8 Quick wins via simplification worth c$10m Fig 9 Lifting store performance Source: Company slides, Macquarie Research, August 2012 Source: Company slides, Macquarie Research, August 2012 It was revealed that currently 20% of stores are loss-making and a further 20% are just covering their return on capital. Management are looking at ways to improve stores to lift them to the next tiering of profitability via improved visual merchandising and high-impact, low-cost store touch-ups. While they have shut stores where it was economic to do so, the remaining unprofitable stores they hope to lift profitability to a neutral ROC outcome. They also revealed that they have brought in Colin Haggerty (from Target Australia and extensive UK retail experience) to bolster Billabong s retail expertise. Fig 10 Supply chain benchmarking Source: Company slides, Macquarie Research, August 2012 A benchmarking exercise was conducted on Billabong s supply chain vs industry peers to compare vs industry averages and best-in-practice and highlighted the inefficiencies in Billabong s supply chain. Many of the inefficiencies were caused due to poor integration of acquired brands as well as poor global systems to monitor, measure and manage supply chain processes. Management expect to gain c$25m from properly integrating and globalising the supply chain by improving absolute costs and also having short lead times and faster inventory turns. 28 August 2012 5
Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie First South - South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down 60 100% in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 40% in a year. Low medium stock should be expected to move up or down at least 25 30% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 30 June 2012 AU/NZ Asia RSA USA CA EUR Outperform 55.67% 61.00% 53.43% 42.58% 69.23% 46.60% (for US coverage by MCUSA, 9.05% of stocks followed are investment banking clients) Neutral 30.50% 22.11% 36.99% 52.41% 28.02% 33.69% (for US coverage by MCUSA, 8.14% of stocks followed are investment banking clients) Underperform 13.83% 16.89% 9.59% 5.01% 2.75% 19.71% (for US coverage by MCUSA, 0.45% of stocks covered are investment banking clients) Company Specific Disclosures: Macquarie and its affiliates collectively and beneficially own or control 1% or more of any class of Limited's equity securities. Macquarie Bank Limited makes a market in the securities in respect of Limited. The analyst and/or associated parties own or have other interests in securities issued by BBG. Macquarie Research is restricted as a result of Macquarie's involvement in the discussions with a potential bidder for as announced by to the ASX on 17 Feb 2012. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures. Analyst Certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN 94 122 169 279, AFSL No. 318062) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. 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The Macquarie Group s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures. 28 August 2012 6