Billabong Has a Meeting

Billabong held its annual shareholders meeting October 25th.  Chairman Ted Kunkel and CEO Derek O’Neill made short speeches you can read here that contained a few pieces of interesting information. Looking over the longer term, however, I am more interested in an issue they discussed and acknowledged as being important, but didn’t really get into at the level I would have liked.

That issue is the question of what percentage of sales can be represented, in the retail they own, by the brands they own.
 
To be honest, I would have managed it exactly the way they did because I wouldn’t have been in hurry to give my competitors any more information than I needed to. And because I’m guessing the shareholders wouldn’t have wanted a two hour speech.
 
I discussed this when I wrote about their annual report for the year ended last June 30th. To summarize, when you buy retail, you do it partly to get the higher margin. But you don’t get that higher margin right away. First, you have to sell the existing inventory at normal retail margins. Second, you have to stock the stores with new inventory, but you only get higher margin when the product sells at retail- not when it goes into the store, which is when you would have gotten it before you owned the store. Third, you have to replace brands you don’t own with brands you do own. The more you do that, the more money you make.
 
Retail represented 38% of Billabong’s revenues in their last complete year, and they didn’t own all of their retail for the whole year. In a perfect world, they’d like to sell only Billabong and Billabong owned brands in their retail stores. But a West 49 store can’t be all Billabong brands and still be a West 49 store. Can it?
 
No, and Billabong knows that. Certainly it can be 30%. How about 75%? At what point does stocking a store with owned brands impact the store’s image and market position? When do the non-owned brands you carry in stores begin to feel like they aren’t getting enough space to be merchandised well and that all they are doing is helping Billabong build its competitive position against them?
 
I don’t think either Billabong or I have a solid answer to that. It probably varies according to brand and retail location. But I bet they are thinking about it every day and I wish they’d talked more about it though, as I said, I didn’t expect them to. This may be the single most important issue, among those they can control, that impacts their future results.
 
CEO O’Neill pointed out that “…the family brand share in all of the Group’s acquired retail operations has been lifting and this is leading to better profitability for the business,” so they are starting to get the promised benefits. 
 
Chairman Kunkel gave us some specific data for West 49. Before the acquisition, Billabong had an EBIDTA of about $5 million from West 49 and “…a store penetration level of 15% company owned product.” For the year that will end June 30, 2012, they expect an EBITDA of $15 million and a penetration level of 35%. Notice that the EBITDA contribution tripled but the penetration level didn’t. That’s the higher margins at work I assume.
 
Just to carry this a bit further, we see that the ratio of EBITDA to store penetration last year was 0.33. In the current fiscal year, they expect it to be 0.43. Now, I don’t quite know what to call that calculation, because I just made it up, but higher is better. If I were Billabong, I’d have a graph that tried to project it as owned brands retail sales grew. I say “tried” because I’m not sure it’s completely a linear relationship as there are other factors involved I’m not sure how to include.
 
Ted Kunkel also said some interesting things in describing the company’s rationale for its increased retail focus. He said the two key groups in the industry were the brand owners and the specialty retailers, with the brand owners being the product innovators and the retailers the “…important interface through which the brands connect with the consumers.” I wouldn’t make quite such a clear distinction. Specialty retailers have a role in product innovation- or at least in trend identification and communication that leads to product innovation.
 
He goes on to say: “One particular trend among the larger mall-based retailers has been a transition to vertical product, thereby reducing the floorspace available to authentic boardsport brands and, in many instances, watering down the appeal of the stores to the core boardsports consumer  demographic.”
 
Certainly this is a valid reason for Billabong, and other brands, to move into the retail space. But if accurate it seems to imply declining importance to the specialty retailer. Or maybe it makes the ones who are left even more important.   
 
Derek O’Neill started his presentation by reminding the audience of some of the challenges they had faced last year even beyond the ones involved in integrating new acquisitions. These included earthquakes in Japan, floods in Australia, weak economies, and a rapidly gyrating Australian dollar. I thought he made an important comment when he noted that it wasn’t the level of the Australian dollar that was a problem, but the volatility. Obviously, Billabong wasn’t the only company affected by these.
 
He also gave us information on what’s happened in the quarter that ended September 30. Total sales were up 24.7% in constant currency. Excluding acquisitions, they rose 6%. In their owned retail in the U.S. same store sales rose 6.4%. Without providing any numbers, he describes their U.S. wholesale business as “stable.” I guess that’s an improvement.
 
No numbers on the Australian wholesale business either, though he indicated that specialty account base was performing “quite well.” Their owned retail business in Australia had positive comps of three to four percent. He described Europe as having “solid revenue growth year to date” but with slightly lower margins due to higher product costs.
 
The year seems to be starting out better for Billabong, with some of the promised improvements in owned retail coming on line and more to follow. Sounds like the wholesale business is a bit more problematic.  Lacking financial statements with a bottom line, we have to be a bit cautious in reaching conclusions about their first quarter performance. My focus will continue to be on the extent to which they can push their owned brands into their retail.