article 3 months old

Not So Fine At Oroton

Australia | Sep 23 2013

-Loss of Polo-Ralph Lauren felt
-Competition pressure on margin
-New brand impetus needed


By Eva Brocklehurst

OrotonGroup ((ORL)), purveyor of luxury accessories, is finding things are not so fine in terms of growing income.

The company delivered FY13 profit of $24.1 million but this was enhanced by the performance of Polo-Ralph Lauren, a brand which the company will no longer sell. To reach guidance for FY14 earnings of $16-18 million implies a strong lift in the Oroton brand. UBS thinks it can be achieved but via marginally stronger sales growth, moderate gross margin recovery and cost reductions. There's no clarity on where any new business may come from and so, beyond FY14, UBS assumes the cost base is reduced to reflect an Oroton-only operating structure.

UBS has opted to retain a Neutral rating on the stock, pending further information on new business. This is the only one on the FNArena database, where the other three brokers rating the stock have Sell ratings. The consensus price target is $5.65, suggesting 7.4% downside to the last share price. The price targets range from $5.20 to $6.00. The dividend yield is 4.7% on projected FY14 earnings and 5.0% for FY15.

Credit Suisse downgraded to Underperform from Neutral on the back of the FY13 report, finding the Oroton brand the key source of weakness with like-for-like sales down 4%. Gross margins contracted 360 basis points. This broker also felt there were a lot of uncertainties facing the company. Oroton Australia is fielding competition from international players and the online presence of these players is increasing. This requires Oroton to be innovative with marketing. BA-Merrill Lynch also thinks a large part of the declining sales trend is the impact of international brands such as Coach and Michael Kors. Potential positive catalysts could be acquisitions, or capital management, but in the absence of any such developments the broker thinks the stock is overvalued.

If both sales and gross margins are declining it usually means the retailer is in trouble, according to Citi. The broker is prepared to give the company the benefit of the doubt. Maybe it was a particularly poor season. There's no doubt competition is rising. Citi expects Oroton will have to lower prices to compete with Michael Kors and another drop in margin will ensue. The Polo brand contributed $23m in earnings for FY13 and this hole will be hard to fill. Citi estimates Oroton generated no sales growth in FY13, with $96.5m in revenue. Management conceded the focus was on the loss of a core brand and that the promotional calendar was not used effectively. The broker is factoring in the acquisition of another brand into the equation but thinks any near-term contribution will be small.

Credit Suisse wants to see the brand reinvigorated with fewer mark-downs. Furthermore, Oroton International does not contribute materially to earnings at present and the pace of expansion is slow in the broker's view. Whilst Credit Suisse acknowledges there is opportunity here, the company appears to need more confidence in the macro environment to accelerate store growth. The Brooks Brothers joint venture, signed in August, in which Oroton has a 51% stake, offers potential and the company is targeting $50m in sales in five years. Credit Suisse remains a little dubious, noting a material increase in marketing and other expenditure is required to support growth in this venture.

The brand has historically outperformed the clothing industry on a like-for-like basis. The take on this from Credit Suisse and Merrills is that it has been driven solely by price increases. Oroton consistently delivered a quality product but now that prices are becoming broadly in line with international competitors such as Coach, the brokers consider there's little scope for further yield expansion beyond the industry norm. Adding to the risks, in Merrills' view, is the likelihood a decline in the Australian dollar will put extra pressure on gross margins.

The maturity of the Australian offering suggests growth is largely dependent on offshore expansion. Credit Suisse notes there are now two stores in Singapore and five in Malaysia, generating around $3m in sales on a net investment of $2m. Oroton plans to open a store in Shanghai and Hong Kong in FY14 and is assessing the possibility of opening more stores in China. A website for China will be launched in October 2013. Oroton has also signed an agreement with a distribution partner in the Middle East to open a store in Dubai in October 2013 and Abu Dhabi in mid 2014. The investment metrics for these sites have not been disclosed.

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