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Treasure Chest: Potential In Kathmandu Turnaround

Treasure Chest | Jun 09 2016

This story features KATHMANDU HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: KMD

By Eva Brocklehurst

Kathmandu Holdings ((KMD)) intends to turn around its performance by improving operations and products, rather than relying on consumer spending or external factors. Yet brokers observe one external factor, the weather, is affecting the outdoor clothing and gear market at present.

The new CEO, Xavier Simonet, is revamping store lay-out, product design and inventory, while undertaking less predictable promotional strategies. These strategies are all expected to drive earnings improvements and growth from existing stores, rather than by opening new stores.

The company is dependent on three key trading periods, two of which are, or were, under pressure, Morgan Stanley observes. The timing of Easter earlier in the year – March instead of April – meant sales were affected and the warm start to winter has also curtailed consumer interest in buying protective outdoor gear.

The company has a strong brand in winter apparel, such as fleece, down jackets and knits and a number of other retailers have also recently suggested the warm winter has hindered sales. Canaccord Genuity suspects consumers may wait for the winter sales (late June), but acknowledges this could affect Kathmandu's winter revenue and margins.

Another aspect currently cooling Morgan Stanley's ardour for the stock is that the newly restructured Ray's Outdoors, owned by Super Retail ((SUL)), means more clearance activity from an emerging competitor. The broker recently downgraded Kathmandu to Equal-weight from Overweight.

Yet Canaccord Genuity is more confident that a turnaround is materialising. Management blamed a poor performance in FY15 on predictable promotional activity, being overstocked, a slowing in consumer spending and carrying higher debt levels than it had targeted.

Now, the broker observes, FY16 estimates reflect more positive momentum, with FY16 revenue of NZD437.6m expected, versus NZD409.4m in FY15, and profit of NZD30.4m versus NZD20.4m. Further improvements are expected in FY17.

Canaccord Genuity factors in a small number of new stores opening each year. Australasia has capacity for 180 stores, management maintains, compared with 160 currently. The broker suspects some poorly-performing stores will be closed each year but management has also assured the market it will not expand for the sake of chasing growth and will avoid cannibalising existing stores.

In discussions with management, the broker notes the company has an unofficial target for long-term debt around NZD40m, averaged through the cash-flow cycle. This compares with the peak of NZD70.9m reported in the first half result. Despite the headline, the company remains within its covenants and, based on its modelling, Canaccord Genuity believes the balance sheet will be within the target range by FY18. Then, capital management strategies may be considered.

The dividend pay-out ratio is currently 50-60% but management envisages an opportunity to raise that to 70-80% over the next few years, once debt levels reach the target. The broker forecasts a AUD7.6c dividend in FY16, based on a 51% pay-out ratio, offering investors a 5.5% yield, 50% franked. This increases to AUD9.2c in FY17, based on a 59% pay-out and offering a 6.6% yield, 50% franked.

Canaccord Genuity believes the stock is good value versus comparable specialty retailers, based on FY16 earnings estimates. If management can prove there is upside from operating efficiency within stores, and the international expansion can occur with minimal risk, then the broker suspects the market may re-rate the stock to a multiple closer to the market average. Canaccord Genuity initiates coverage with a Buy rating and $1.60 target.

The company currently operates 162 stores across Australasia and the UK and an online store. The brand manufactures and sells apparel, footwear and technical equipment targeting hiking, camping, snow, water sports and cycling markets. Canaccord Genuity notes the challenges in the industry include relatively flat participation rates for outdoor activities and the fact that consumers tend to head to gyms, running or yoga rather than traditional hiking and climbing markets.

To counter this trend the company has become more involved in the yoga and running markets and is also intent on bringing a higher level of fashion to its regular product range, as outdoor wear transitions to day wear. The adventure traveller has also become a key target in the technical ranges of apparel, luggage, footwear and accessories.
 

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