False hope you can believe in: Pacific Brands' turnaround

Brands are often a source of above average profitability – but not always. Tally up Pacific Brands' (ASX: PBG) cumulative net profit for the past decade and you arrive at a pretty sobering sum: negative $652 million.

For ten years, we've bought Bonds underwear, Sheridan sheets and dozens of other Australian icons from the company. Staff have diligently turned up to work each week, and shareholders held on for dear life as the stock lost 80% of its value. There was a major capital raising in 2009, and 'one-time' restructuring costs were incurred in five out of ten years. So much effort. The net result? A loss of roughly $180,000 a day.

Yesterday, though, investors were cheering. The stock jumped 50% after the company announced it would be debt free for the first time since listing in 2004. What's more, 'strong performance of Bonds and Sheridan retail, disciplined margin management and cost control' led to a profit upgrade. Full-year operating earnings are now expected to be $63-65m, up from $57-63m. Finally, is this the turnaround everyone's been waiting for?

Colour us sceptical.

Management has done a commendable job selling off dead brands and reducing debt, while its shift to a direct-to-consumer strategy is sensible. But Bonds and Sheridan operate in a hotly competitive market. And then there's the issue of powerful customers: two-thirds of sales still come from just a few large customers like David Jones, Target, Big W and Woolworths (ASX: WOW), which are now promoting their own private labels and squeezing Pacific Brands' wholesale margins.

Let's not forget that store rollouts can also go horribly wrong, as Billabong's (ASX: BBG) recent experience attests. Management is new to the game, so more time is needed before we can truly establish that it has what it takes to be a successful retailer over the long term.

The biggest threat to shareholders, though, is the company's international expansion. Sheridan is now sold in China and has stores in London, while Bonds is distributed in New Zealand, Canada, USA, Singapore, the UK and China.

When an Australian teenager walks proudly down the street with his pants around his knees to show off his new Bonds underwear, it may seem ridiculous to the rest of us. But it's that brand loyalty that allows Pacific Brands to charge a premium price. With no overseas brand recognition, Chinese and Canadian teenagers probably won't be prepared to pay up in the same way that Aussies are. The possibilities are endless, and so are the risks.

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