Australia | Sep 06 2021
This story features KATHMANDU HOLDINGS LIMITED. For more info SHARE ANALYSIS: KMD
While Kathmandu's share price languishes nearly -50% below pre-covid levels, new broker research suggests earnings should double over the next three years.
-Earnings may double over the next three years
-Shares at a material discount to A&NZ retail peers
-Solid market share gains for Rip Curl
-A 2022 launch of the Kathmandu brand in Europe
-Rising cotton prices are a key cost input
By Mark Woodruff
Since the pandemic started, there has been increased interest in hiking and additional popularity of surfing, which has also stemmed from surfing’s recent inclusion as a sporting event in the Olympics. One way for investors to ride this wave is via shares in Kathmandu ((KMD)), which have fallen nearly -50% below pre-covid levels.
The share price was significantly impacted in early 2020 as the pandemic hit retail stocks through store closures and falling foot traffic. More recently, the share price decline has been attributed to continued negative pandemic news in Australia, and lately New Zealand.
A market leader in the Australian and New Zealand outdoor apparel space, the company is an outdoor, lifestyle and sports company. Key competitors include Macpac, The North Face, Mountain Warehouse and Torpedo7.
The company’s Outdoor segment (Kathmandu and Oboz brands) accounted for 61% of FY20 sales, 88% of which related to the Kathmandu brand. The Surf segment contains the Rip Curl brand, including the Ozmosis group of multi-brand surf stores.
The company’s store footprint has grown to around 162 stores currently from 97 stores in FY10, and sales per store have been kept reasonably constant in the process.
UBS has initiated coverage on the company with a Buy rating and price target of NZ$1.70. Upside to this target is likely driven by a successful launch of the Kathmandu brand outside of A&NZ and solid market share gains for the Rip Curl brand.
While there’s likely to be pressure on short-term A&NZ sales due to continued covid disruptions, UBS believes earnings should double over the next three years. Earnings drivers include the re-opening of A&NZ stores in combination with increased consumer spending. Additionally, a solid margin recovery is expected along with the growing global popularity for surfing.
Despite a strong growth profile and potentially less earnings volatility after the Rip Curl acquisition, the company trades at a circa -20% discount to A&NZ retail peers on a one year forward price earnings multiple.
Top-line growth in the outdoor segment is underpinned by data pointing to continued consumer preferences for athletic clothing and solid medium-term consumer expenditure growth forecasts, explains the broker.
Macquarie sees positive signs for the company’s offshore exposure via a read-through of results from overseas peers. The demand for footwear continues to be robust and is outpacing production capacity, while there appears to be continued strength for US surf retailers.
When compared to FY19, the analyst expects FY21 and FY22 top line growth for footwear brand Oboz of 6% and 13%, respectively, and 3% and 10% growth for Rip Curl. The broker has set a Neutral rating and a 12-month price target of $1.35.
Meanwhile, Morgan Stanley has its target at $1.80 and has an Overweight rating in the assumption lockdowns are transitory. The analyst recommends buying on any share price weakness, given the company is leveraged to re-opening economies and a shift to outdoor activities.
When the company issued a trading update in late June 2021, Jarden lowered forecast earnings. This was entirely driven by lower Kathmandu Australia earnings on lower sales, gross margin and fixed cost leverage. No meaningful change was made to earnings forecasts for Rip Curl or Oboz. The broker, not one of the seven brokers monitored daily on the FNArena database, reiterated its Buy rating and NZ$1.75 target price.
Canaccord Genuity, also not one of the seven, sees Kathmandu as a long-dated reopening play and feels earnings are likely on an upward trajectory. This stands in contrast to most of the other ‘cheap’ small cap retailers that have had a stellar year in 2020/21 though are potentially looking at negative EPS momentum into FY22.
Also in reaction to the June trading update, the broker upgraded its rating to Buy from Hold and raised its target price to $1.48 from $1.25. The analyst noted Rip Curl continues to trade well with direct-to-consumer sales well above pre-covid levels and wholesale orders similarly strong. Oboz has also seen record sales in the second half, and wholesale orders for FY22 are significantly above FY19 and FY20.
Margin improvements should result from growth in the online channel and a lower lease liability after the Rip Curl acquisition. Also, UBS data suggests an improved pricing opportunity as peer discounting has come down since the pandemic. Earnings margins are expected to improve by more than 500bps over FY20-FY23.
Management has a margin target of 15% within the next three years and the broker’s analysis points to margins of 16% from FY23. Ongoing margin pressure is expected from local lockdowns and high raw material costs in the near term, though covid-impacted gross profit margins should normalise from FY23.
Cotton prices are a key cost input for the company’s cost-of-goods-sold (COGS), and these prices have increased significantly over the last few months as a result of the textile industry’s demand booming over supply. However the broker expects this should be partly offset by higher sales prices and less discounting, with the pandemic offering an opportunity for a promotional reset.
Cost synergies between the Surf and Outdoor segments are estimated by management at around $15m per year. This will be partly offset, as management has pointed to a post-pandemic increase in promotional activity spend and higher administration and general expenses for the surf segment.
Online presence building
Online sales for the Kathmandu brand have grown at a 29% compound annual growth rate (CAGR) to $81m in FY20 from $10m in FY12. The pandemic has driven a large portion of this increase, with more than 60% growth in online sales for FY20.
Following the Rip Curl acquisition in 2019, the well-diversified portfolio provides room for global growth, in UBS’s view.
Kathmandu is planning a soft-launch of the Kathmandu brand in Europe in 2022, where it will approach the market through the Rip Curl channel which has established legal entities and warehouses in Europe.
As there’s limited proof of this growth strategy at the moment, UBS doesn’t include growth outside of A&NZ in its base-case scenario. In an upside scenario the analyst sees growth adding around $30m in revenues in FY24.
During the pandemic, wholesale was the most impacted channel for the Surf segment, as retailers significantly lowered their purchases.
In the short term, an improvement in wholesale orders should lead to strong near-term growth from the first half of 2022, expects UBS. In the long-term, it’s thought online will be the fastest growing channel as Rip Curl accelerates growth by leveraging on Kathmandu’s online capabilities.
The broker’s analysis points to a strong long-term growth opportunity in North America, as Rip Curl has grown to be among the top six brands', compared to ten years ago when it was ranked twelfth.
Data suggests strong technical (eg wetsuits, boards and high-tech watches) surf sales growth, which account for around 40% of Rip Curl sales. There’s also evidence suggesting Rip Curl is one of the most preferred brands in New Zealand, notes the analyst.
Jarden also approves of what the 2019 acquisition of Rip Curl brings. It’s thought to provide not just product/brand diversity but also geographic and channel diversity, all of which help reduce earning concentration and risk profile.
FNArena’s database has three broker ratings with two Buys and one Hold rating and a consensus target price of $1.58, which signals 18.4% upside to the last share price.
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