Billabong Reports Deteriorating Sales Growth Trend; The Strategy or the Economy?

Billabong’s announcement about sales trends since the end of October and the actions it’s taking may portend issues for other companies as well as for Billabong. Let’s take a look at what they announced, what actions they are taking, how they found themselves in this position, and how it relates to the global economic environment.

Here’s what they said (you can go here to read the announcement and the transcript of the conference call):

“Following receipt and finalization of management accounts reflecting actual trading results for the month of November and receipt of preliminary retail sales data for company owned stores for the period ended 11 December, the sales growth trend has deteriorated significantly in this critical retail period.”
They report that constant currency sales revenue growth for the three months ended September 30 was 24.7%. For the four months through October 31 it was 17.2% and for the five months ended November 30, 11.7%. If you exclude acquisitions, the numbers were 6.2%, 2.8% and 0.4%. Remember these are constant currency numbers. I don’t know what the “as reported” numbers will look like.
For a single month, and then two months, to pull the numbers down this hard means that things went south pretty quickly, and apparently so far they aren’t looking good in December. Remember that a lot of business is done during the holiday season, so these percentage declines translate into a whole lot more dollars than they would at other times of the year.
“Based on preliminary sales data to 11 December and assuming a continuation of current trends, it is now anticipated that sales revenue for the six months to 31 December will be approximately 5% higher than the pcp [prior calendar period] in constant currency terms (down approximately 3% adjusting for the impact of acquisitions).”
 They say this “…reflects the European sovereign debt issues and the ensuing fears of global recession which are impacting consumer confidence and spending patterns significantly.” You can read their description of conditions in each region in the announcement. Weather has made a difference in both Europe and Australia. Billabong reports seeing “very low” sell through at retail, and poor reorders. CEO Derek O’Neill notes that reorders “…must be at reduced prices due to large amounts of unsold inventory washing through the marketplace therefore impacting gross margins.”
Basically, Europe is the toughest market followed by Australia and then the U.S. But whatever strength there was in the U.S. apparently dissipated in the first two weeks of December “…on growing global concerns about Europe. Challenging trading conditions remain in Canada, in both wholesale and retail.” 
In discussing the U.S., CEO O’Neill refers to some weakness from PacSun orders related to their accelerated store closing. He estimated Billabong had lost a “couple of million’ in business over the last four weeks as a result. I had highlighted this issue when I reviewed PacSun’s results.  I’m sure other brands will experience similar impacts consistent with their exposure to PacSun.
The good news is that Asia continues to perform well and Japan has rebounded. They also note that they have a “low double digit forward order book for late Spring and Summer in the USA in the wholesale business.” They had noted, however, that some orders (not just in the U.S.) had slipped from first half to the second half, and I wonder how that might impact those comparisons.
The result of all this is that Billabong expects their EBITDA for the six months ending December 31 to be between $70 and $75 million Australian dollars compared to $94.6 million in the same period the prior year.
Remember, so far the other public companies have reported just their end of quarter results- typically for October 31. None have felt an obligation to stand up and announce that conditions have gotten tough since then. But they report earnings every quarter where Billabong reports only every six months. I suppose these conditions could be unique to Billabong, but that seems improbable. It’s my belief that the on again, off again meetings about European sovereign debt and the growing realization that nothing has actually been done to solve the issue is creating a global caution among consumers.
What’s Billabong Doing?
I have the sense from the conference call that Billabong was a bit caught by surprise by the extent of the decline, but they seem to be acting decisively. The first thing they are doing is working to move inventory. This is in contrast to the position they took when the financial crisis hit in 2008. At that time, they indicated they were more concerned with holding margins and brand position than with losing some sales. They choose to be less promotional than others as a matter of brand positioning. Not so much this time I guess.
They are also undertaking a complete operational review to see where they can take costs out of the company. I expect that will reverberate through all their brands and locations.
Next, and most intriguing, a “strategic capital structure review” is under way with Goldman Sachs, the company’s advisor. What they indicated was that nothing was off the table, but raising more equity was pretty much the last choice. That makes sense when you note that their stock closed today (Tuesday) at AUD $1.77.
So that means that besides reducing expenses there’s at least the possibility of selling a brand, accelerating the closing of underperforming stores, maybe raising some kind of convertible debt, or, I guess, even selling the company.
They are doing this because their balance sheet position may require it, especially if business conditions deteriorate further. They noted that they were not in violation of any of their banking covenants as of December 19, but would not speculate on where their debt coverage ratio would be at the end of December. CEO O’Neill said the poor business conditions were “…expected to result in a deteriorating leverage position [at December 31].” Here’s how CFO Craig White puts it:
“The fact is that we’ve gone from a position where I could say that we were comfortably within covenants to a position that’s less comfortable, but I’m not going to speculate on where we’ll end up at the end of December. There’s a lot of things that can move around in that time.” 
It’s reasonable of them to say that they don’t know yet where they will be at the end of December. December, as they point out, is a big month. But they are concerned enough that they’ve got Goldman Sachs looking at their choices. How did they get to this position?
Good Strategy, Bad Timing?
During the conference call, CEO O’Neill continued to support the company’s overall strategy of retail growth. He discussed the systems they have in place to manage it, and the progress they are making of getting better product to market faster in a more coordinated, efficient way.  The more or less unspoken question during the call was “Hey, if this strategy is so hot, how come you got Goldman Sachs helping you figure out how to strengthen your balance sheet?!”
It’s not a bad question. As you recall, the West 49 acquisition was a big one. And it came along not necessarily at the time Billabong wanted it to. But there it was looking too good to pass up and fitting the company’s strategic criteria. You may remember they borrowed a bunch of money to pay for it, and I noted at the time it was a good thing they’d raised some capital earlier when they could even though they didn’t need it or the deal probably couldn’t have happened.
The other thing I emphasized was that buying a turnaround, which West 49 clearly was, was a whole different story from buying a solid brand or retail chain with a history of profitable growth and strong management in place. If they’d asked me at the time (they didn’t) I would have told them that whenever I’ve walked into a turnaround, it’s always been worse than I expected before I got there.
In a stronger economy, that might be an inconvenience. In a lousy one, it’s a problem. I’m not suggesting that the West 49 deal is the basis of all Billabong’s issues. The economy would still suck even without it. But if they didn’t have the debt they used to pay for the company, and hadn’t had to invest management time and some money into integrating and cleaning it up and stocking it with more of their owned brands, maybe they wouldn’t need Goldman Sachs to help them work through their potential balance sheet issues.
This is a tough situation that’s come on Billabong pretty suddenly. There were some concerns over the inventory and balance sheet at the last review but clearly they’ve accelerated due to deteriorating business conditions. There appears to be a not trivial chance that Billabong will violate some of its bank covenants at the end of the year.
The thing is, if it’s a small violation and you can see how it’s going to work its way out over a quarter or two, you don’t necessarily need Goldman Sachs to help fix the problem. What I might do (what I have done) is go to the bank and have a conversation about a soft quarter, and cash flow, and how it’s just a temporary thing, and about how I’m going to fix it, and couldn’t they see their way clear to waive the covenant for may six months, and yes, of course I’d be thrilled to pay them a fee to do that. Grovel, grovel, grovel.
Banks are a little more gun shy than they use to be (10 years too late may I point out), so maybe it’s not that simple. I still think the Billabong strategy makes sense as long as they exercise some caution as to how much of their owned brands end up in their owned stores. I also continue to think that tough times create opportunities, but only for those with strong balance sheets. Billabong apparently needs to shore their balance sheet up. We’ll find out in February if not before by how much and what they do.