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Uncertainty Clouds The Outlook For Kathmandu

Australia | Mar 25 2015


-Slower Oz store openings welcomed
-Dividend yield support
-Retreat to traditional ranges
-Price reaction a corporate signal?


By Eva Brocklehurst

Kathmandu ((KMD)) had a tough first half. The company cleared inventory aggressively in August and September, which drove top line sales but lowered gross margins. Christmas trading deteriorated sharply and comparative growth in Australia was weak. Broker opinions are divided about the extent to which the company can turn around, and how quickly. They are unanimous, however, on the fact that uncertainty clouds the outlook.

Morgan Stanley looks past the near-term weakness and believes the current sell-off puts the stock at an attractive entry point vis-a-vis a six to twelve month view. The broker suspects the clearance in August-September cannibalised sales later in the half, whilst a weak retail environment in Australia also affected the business. The company now plans to slow its roll-out of stores in Australia and focus on existing stores, and Morgan Stanley welcomes this move. From FY16 inventory will be more optimised with stocking on a store by store basis. The broker expects this to be of help to the smaller outlets in Australia which have underperformed.

Expenditure of around NZ$5m per annum is targeted for building the brand in the UK and Morgan Stanley believes capitalising this cost undervalues the business. The broker maintains a positive view and considers one-off issues drove the first half loss. A cleaner inventory position and a focus on improving performance is expected to ensue so an Overweight rating is retained by the broker.

The results highlighted a deterioration in Australian sales and gross margins for Deutsche Bank, which suggests that customers are increasingly blase about the company's traditional promotions. The broker acknowledges the company is reassessing its sales strategy but believes weakness is exacerbated by a more aggressive push into the UK and a transition in the CEO. This adds up to more uncertainty over the next twelve months. While the stock enjoys dividend yield support and leverage to a cyclical pick-up, the broker is cautious and maintains a Hold rating, wanting evidence of stabilisation before becoming more positive.

Deutsche Bank also observes comparative growth in Australia was just 0.9%, well down on the five-year average of 9.0%. This reflects not only soft consumer sentiment but also brand-specific issues, with a failure to drive sales through promotional activity. Moreover, Deutsche Bank refers to the trading update for the seven weeks to March, which shows a reduction in like-for-like growth of 2.0%. The first week of Easter sales was soft in Australia albeit satisfactory in New Zealand, the company reported.

Macquarie considers weaker sales in non-technical ranges have implications for just how much the brand can be stretched. Management has flagged a reduction in these ranges and a reassessment of promotional activities, citing a need to reduce the number of days the brand is on sale. Macquarie suspects the casual/urban ranges were important contributors to the Australian store network and provided some of the justification for smaller format stores in shopping centres. The broker considers a retreat to focus on technical ranges is significant in terms of the longer-term returns from these higher rent locations.

Initial results in the UK from promotional campaigns have been positive but Macquarie considers it too early to draw conclusions from that geography. The broker also points out the new CEO, Xavier Simonet, will start on July 1. Acknowledging that the near term multiples are undemanding, Macquarie still expects the stock to trade with a high degree of uncertainty until there is evidence the longer-term strategic issues are addressed.

Low confidence in the earnings outlook makes pointing to valuation metrics rather futile, in Morgans' view. Still, the broker likes the brand and expects a more targeted promotional strategy could lead to renewed upside in the medium term.

The near-term outlook may be soft but Credit Suisse considers it naive to discount the potential for the slump in the share price to attract corporate activity and revises its recommendation to Outperform from Neutral. The broker also observes that while New Zealand gross margins deteriorated, this was nowhere near the magnitude of what occurred in Australia. The broker likes the conservative stance regarding store roll-out in Australia, given current trading conditions, and the fact the company has conceded that the aggressive clearance activity in the first quarter did not help the brand, or the finances.

The stock has two Buy ratings and three Hold on the FNArena database. The consensus target is $1.70, suggesting 22.1% upside to the last share price. The dividend yield on FY15 and FY16 earnings estimates is 5.2% and 6.0% respectively.

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