More hard yakka ahead for PacBrands

When John Pollaers quit as chief executive of Pacific Brands earlier this year the explanation given was that a divergence of views between him and the board had become apparent during a strategic review of the perennially challenged business by Macquarie Capital.

Today’s announcement of the sale by PacBrands of its workwear division (which includes iconic brands like Hard Yakka, King Gee and Stubbies) to Wesfarmers for $180 million might be interpreted as confirmation of the speculation that the divergence related to the fate of that business.

That doesn’t appear to be the case -- indeed there appears to have been a deeper philosophical divide between a growth-oriented CEO and an increasingly nervous board. The sale of the workwear brands appears to be more of a symptom of that divergence of views than its cause.

Pollaers, who was CEO for just under three years, had been pursuing an unabashed growth agenda that involved heavy investment in brands and innovation and a big drive into expanding PacBrands’ direct retail and online channels.

Again, the strategy itself doesn’t appear to be the cause of the collision between CEO and board.

PacBrands embarked on a roll-out of its own retail network because its wholesale business was being crushed by the pressure on its big discount department store customers, both from the external retail environment and more particularly the disruptive, margin-throttling Kmart strategy of focused high-volumes and low-price.

Under its newly appointed CEO, its former chief financial and operating officer David Bortolussi, PacBrands appears committed to that strategy of continuing to expand its direct-to-consumer distribution channels.

There was, however, a cost to Pollaers’ growth strategy and the pace at which it being pursued and it showed up quite markedly in the results PacBrands unveiled today.

The positive note was that it had driven top-line growth, with sales up 3.8 per cent. The downside was a 28 per cent decline in earnings (before significant items) from $73.8 million to $53 million and, more particularly, a blowout in net debt from $159.1 million to $249.1 million. The significant items -- $277.5 million of largely non-cash writedowns – pushed the overall result heavily into the red, with a $224.5 million loss incurred.

For a board that has been battered by six years of restructuring and down-sizing and losses as the group battled to survive in the post-financial crisis environment, the rapid escalation in debt and costs (up 5.4 per cent) associated with Pollaers’ dash for growth and a severe deterioration in cash conversion (down from 106.9 per cent to 43.6 per cent) would have triggered some alarm bells.

The appointment of Bortolussi points to the new imperative. The board wants to get its balance sheet and the latent threat posed by the rising tide of debt back under control.

The sale of the workwear brands to Wesfarmers will go a considerable distance towards achieving the stability. Workwear has been a casualty of the downturns in the industrial and resource sectors, with the division’s earnings before interest and tax, and before significant items, down 41.1 per cent to $22.1 million. Impairments of goodwill and brand names drove the division to a $247.4 million loss.

The business and its brands are thought to have considerable potential both in the domestic market and offshore. PacBrands, however, doesn’t have the balance sheet to ride through the uncertainties of what could be a long cycle of lower demand.

For Wesfarmers the amounts involved are immaterial and the acquisition will, if the Australian Competition and Consumer Commission doesn’t intervene, complement its existing industrial and safety division and generate meaningful synergies and growth opportunities.

The Macquarie review is continuing, which presumably means there will be more changes to the residual (and much-diminished) PacBrands portfolio.

The strategy appears to be to focus PacBrands’ resources on its two core brands, Bonds and Sheridan, where the Pollaers strategy has gained real traction.

Bonds’ sales were up 20 per cent and Sheridan’s 16 per cent as the group grew its retail sales from 14 per cent of its business to 19 per cent and doubled its online sales from 2 per cent of the business to 4 per cent.

Earnings were down, but much of that can be explained by a significant increase in investment in the brands and the distribution networks as well as by the really tough retail environment and its impact on PacBrands’ wholesale business.

It is obvious that PacBrands will continue with the Pollaers strategy for those brands, but at a somewhat slower pace as it tries to balance growth and the costs of achieving it. It is also obvious that everything else in the portfolio is going to be under the Macquarie microscope, with loss-making or underperforming brands either sold or discarded as PacBrands seeks to continue to shrink and simplify the once-sprawling portfolio.

Bortolussi (who had worked with Pollaers at Foster’s) was the obvious person for the job. He needs to get costs down, cash flows up and continue to reduce debt while maintaining, with the help of the workwear sale, support for his two core brands.

In the near term, at least, that’s primarily a finance role and one better undertaken by an insider. It would have been difficult, in any case, to attract a suitable candidate from outside the company at this latest of a succession of difficult moments in its history.