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Oroton’s Upside Lies In Asia

Small Caps | Sep 29 2014

-New brands about to break even
-But margin recovery constrained
-Oroton Asia gaining momentum


By Eva Brocklehurst

OrotonGroup ((ORL)) has struggled to overcome the loss of the Polo licence and, with a lacklustre FY14 out of the way, the luxury goods retailer is intent on restoring its gloss via new licences and an expansion of the Oroton brand in Asia.

Both the newly acquired Gap licence and the Brook Brothers joint venture sustained small losses in FY15 and break even is possible for these brands in FY15. More stores will open and this should help diffuse costs. Still, the brands are in their infancy in Australia and Citi is cautious about their prospects, as competition is high and there is a long inventory cycle under the licence arrangements in the case of Gap. The working capital position is better than under the Polo licence because for Gap there is a long payment cycle. Citi expects margin recovery will be constrained by expansion of other global luxury brands in Australia.

The Oroton brand revealed good like-for-like sales growth in FY14 but brokers are wary that a large portion of this growth was attributable to discounting. The company has signalled a desire to restore margins, and Citi expects improvement is on the way, but gross margins remain a long way below peak levels of FY11. The broker believes the opportunities are well reflected in the share price and maintains a Neutral rating. Goldman Sachs is of a similar view, believing margins will remain under pressure in Australia as the company will find it hard to wean consumers off discounting, suspecting they may have become accustomed to a high level of price promotion.

OrotonGroup has significant potential, longer term, as it eliminates losses from the Gap and Brooks Brothers ventures as well as the new Asian stores. Goldman estimates that, in the FY14 results, the combined loss of these business represented over 30% of group earnings. Goldman also agrees most of the potential is largely factored into the share price and has a Neutral rating and $4.60 target.

After adjusting for the dilutive impact of lower margin sales from Gap, the core Oroton brand's gross margin declined domestically, which UBS puts down to excessive discounting. If the company can improve clearance in Oroton, reduce start-up losses internationally and deliver profit from Gap and the Brooks Brothers JV, then earnings growth could be strong for years to come, in the broker's view. Over the longer term UBS suspects OrotonGroup could also become an attractive takeover target as it gains a material presence in Asia.

Oroton Asia has five stores in Malaysia, three in Singapore, two in China and one in Dubai. Credit Suisse expects a further 4-8 stores will open in Asia over the next three years. Malaysia has already reached positive cash flow and Singapore should be currently nearing that status. Credit Suisse believes there is potential for OrotonGroup earnings to double, perhaps more than double, over the next three years. Oroton Asia is gaining momentum, while Gap delivered positive sales growth and the broker expects break even in FY16. Improved brand awareness for Brooks Brothers should complement the other two brands. What else is new? OrotonGroup is in discussions with Banana Republic for the launch of that brand in Australia. Credit Suisse does not include this in forecasts as a potential launch is unlikely prior to 2016.

FNArena's database contains two Buy ratings and one Hold for OrotonGroup. The consensus price target is $5.06, suggesting 16.2% upside to the last share price. Dividend yield on FY15 and FY16 forecasts is 5.0% and 7.0% respectively.

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