Billabong fights big swell

Billabong International’s interim result was terrible. Revenue fell 8.1% to $699.6m, while the $534.5m writeoff to its namesake Billabong brand and Nixon joint venture led to a $536.6m loss. Can shareholders expect a dividend? Not a chance.

If you were expecting a speedy recovery to Billabong’s fortune, you should be disappointed. If, like us, you take a longer view, things aren’t quite as bad as they appear.

As with the company’s possible suitors, which include VF Corp/Altamont Capital and Paul Naude/Sycamore Partners – we’re more interested in the company’s potential rather than current performance. From this aspect, beyond the sea of red was a glimmer of hope.

The reported numbers are messy, impacted by the formally fully-owned Nixon business in which Billabong now owns a 48.5% stake through a joint venture. There were numerous significant items.

So it makes sense to look at the adjusted numbers, although even those are somewhat misleading. As foreshadowed on Bristlemouth, provisions made in previous periods have been released to boost current performance. Indeed, without the release of these provisions the underlying result would have struggled to break even.

In Europe, the business suffered. Selling pricey surfwear in a recession ain’t easy, although sales of its Dakine and Element brands performed well. In this part of the world, revenue fell 23.2% and earnings before interest, tax, depreciation and amortisation (EBITDA) collapsed 79.1% to $2.4m.

Across the Atlantic, the Americas division did better than expected. The company's newer RVCA brand continues to grow, although the Billabong brand performed poorly. Whilst sales fell, EBITDA increased, helped no doubt by previously written down inventory.

We’ll settle for a slight improvement. In the context of rival Quicksilver's recent results, this part of the business is doing well. The US itself was flat and the Canadian business continues to struggle, with like-for-like sales down by around 8%.

In Australasia, sales also fell 2.6% to $275.9m. Adjusted EBITDA, as with the Americas, was up, again benefiting from provision releases. This was driven by a fall of around 3% in like-for-like sales through its bricks and mortar stores, whilst online sales jumped about 50%. The company’s surfstitch online store could even be sold to help release cash for the business.

Brand values slashed

Perhaps most surprising was the performance of Nixon. Since Billabong sold a chunk of its investment in the brand in early 2012 the business has struggled as a standalone entity.

We were expecting a dividend of around $4m from this business but it came in at just $1.1m. This fall is largely explained by a previously undisclosed arrangement whereby the other joint venture partners – Nixon management and Trilantic Capital – hold preferential equity, allowing them first dibs on any profits.

This has dampened Nixon’s planned push into Asia, although that is of no great concern. Nixon accounts for only a small portion of Billabong’s value.

The book value of the Nixon joint venture and the namesake Billabong brand were cut to $30m and $29m respectively. It’s a write-off that appears excessive, more representative of accounting standards than actual long-term value.

Management cut full-year guidance to EBITDA of $74m-$85m from $85m-$92m – although in a situation like this, one wonders why management bothers with guidance at all.

Hard turnaround

Shareholders shouldn’t be too focused on this result; it’s the turnaround strategy that will make or break this business.

On that front, management has been making progress. Store closures now total 118, with 40 more to go by June. This will leave the business with around 470 stores. Fewer stores will reduce rent and help free working capital for other initiatives. Suppliers have also been culled from 270 to 50 and styles across each brand are being reduced.

To support these changes a rejuvenation of the Billabong senior management team is well underway. A new chief financial officer has started, as has a new head of IT. Further appointments are expected in the areas of supply chain and operations, human resources and brand portfolios.

After several capital raisings net debt has fallen but is still higher than we'd like, and the interest bill is only covered 2.3 times by cash flow. Management admits this is tight but expects to have enough cash to see it through.

The bids from VF Corp/Altamont and Paul Naude/Scamore are due by the end of the month. This may bring a swift end to Billabong’s turnaround but finalisation is critical. The constant bids are distracting for management, and costly – Billabong spent $5.8m in the past half on bid-related expenses.

Billabong’s share price is unchanged since 25 Feb 13 (Speculative Buy – $0.84) and we’re happy enough with progress. SPECULATIVE BUY.

Note: The model Growth portfolio owns shares in Billabong International.