Specialty Fashion drowning in Rivers

The clothing retailer's latest acquisition continues to weigh on earnings, with no indications of a turnaround.

Specialty Fashion Group continues to struggle to integrate the recently acquired Rivers business and delivered another challenging set of numbers for the first half of FY15.

Key take-outs from the result include:

  • The group reported comparable sales growth of 5.7 per cent excluding the recently acquired Rivers business.
  • Operating profit (EBITDA) was down 27.5 per cent on the previous corresponding period (pcp) to $22.6 million.
  • Free cash flow (pre-dividends) was $19.9m, despite a $15.4m reduction in working capital.
  • Gross margin declined from 63.6 per cent to 60.2 per cent.
  • Net profit declined to $5.9m, with the fall materially due to the $16.2m delivered in the pcp.

Consistent with a number of other retailers, we are encouraged by 5.7 per cent comparable store sales growth. This is in line with the report that we wrote last week on the topic (see Retail stocks rise again and Three reporting season take-outs).

However, at an operating profit level this is clearly another very challenging set of numbers. The key area of weakness was the Rivers business, which delivered an EBITDA loss of $11.2m.

At the time of acquisition, Rivers had appeared to be a compelling opportunity, with Specialty Fashion picking it up for $5.3 million in 2013. However, the integration has been less than smooth. Much of the trouble has been due to the challenges of clearing the old inventory.  Moving forward there remains a risk of price deflation as well as foreign-exchange led input cost inflation, placing more pressure on earnings margins.

In addition, the first half result was hedged at a rate of AUD/USD $0.90 while the second half for FY15 is hedged at $0.88. The lower AUD/USD exchange rate will clearly be a drag on reported earnings in FY16 as the company has a number of USD denominated costs.

If the group can get the Rivers business back on track it is worth noting that the group has $48.2m of franking credits on the balance sheet. While this is a consideration for the very distant future it does position the company well in regard to capital management if its fortunes ever turn around.

We have moderated our earnings forecasts to account for the continued challenges in the Rivers business. Our price target declines to 63 cents.

With limited asset backing valuation support, in our view there are better places to gain retail exposure, until at least some indications emerge that the rivers acquisition is turning around.

To see Specialty Fashion Group's forecasts and financial summary, click here.

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