Billabong expects the ongoing rise in cotton prices to prompt an increase in apparel prices at retail throughout the industry and around the world around April or May, starting probably in the U.S. where apparel prices have not risen much lately. Like others, the Australian surfwear company is also concerned about the effect on the supply chain of higher manufacturing costs, especially in China, and potential delivery delays due to factory closures and growing demand.
Cotton represents on average about 40 percent of the production cost of a garment for Billabong. The company's chief executive, Derek O'Neill, said that the group will seek to mitigate the impact of higher costs but ultimately some of the increase will have to be passed on to consumers. The group built up inventories to 320.6 million Australian dollars (€235.3m-$324.8m) at the end of 2010 in view of the price increase and to ensure continuity of supply.
In the first half ending on Dec. 31, Billabong's revenues rose by 15.8 percent to A$834.9 million (€612.7m-$845.9m). At constant currency rates, turnover was up by an even heftier 24.4 percent rate. The growth was driven by the acquisition of retailers – West 49, SDS/Jetty Surf and Rush Surf – and of the RVCA brands. Excluding acquisitions, the growth rate reached a “mid single digit” figure.
In constant currency terms, sales were up over the six-month period by 38.2 percent in the Americas, by 14.3 percent in Europe and by 13.0 percent in Australia, New Zealand and Asia. In Europe, where the turnover increased by only 14.3 percent in reported terms to A$157.2 million (€115.4m-$159.3m) during the period, sales were driven by the Element, Nixon and DaKine brands in Germany, France and Central Europe as well as improved at directly operated stores (DOS). The group suffered in Spain, where the Billabong brand has a strong presence.
North American sales were bolstered by the acquisition of the Canadian retailer West 49 and continued improvement in the business environment in the U.S. Comparable store sales were up by a solid single digit in the last four months of 2010 in the U.S. and surged into the teens in January. Canadian sales were affected by the strengthening of the Canadian dollar, which prompted some consumers to buy in the U.S.
In Australia, the group faced a weak apparel market and poor weather conditions. Queensland, where the group has 60 DOS and achieves 30 percent of its domestic revenues, was hit by floods in December and January. Sales picked up in the country with the return of warm weather around mid-January, resulting in strong growth in comparable store sales. Sales rose significantly in Asia, including Japan.
The consolidated gross margin fell slightly in the first half to 54.3 percent from 55.5 percent in the same period a year ago. The acquisition spree contributed to diluting the group's Ebitda margin to 11.3 percent of sales from 17.1 percent a year earlier, due in part to onetime merger, acquisition and restructuring costs of A$10.3 million (€7.6m-$10.4m). Excluding these costs, the Ebitda margin was 12.6 percent, down by 4.5 percentage points.
Europe became the company's most profitable area for the group, even though the Ebitda margin slipped there to 19.6 percent from 20.8 percent due to higher input costs. Europe overtook Australia, New Zealand and Asia where the margin plummeted to 19.3 percent to 28.2 percent due to the weak economic environment in Australia and the acquisition of SDS/Jetty Surf and Rush Surf. In the Americas, the margin was down to 11.4 percent from 14.0 percent.
The diversification of the brand portfolio also dragged down the contribution of the Billabong brand to less than half of the group's total revenues for the first time. The company will seek to find the right mix of Billabong brand products in its DOS and expects it will vary greatly, ranging from 40 to 70 percent, depending on the banner and the location. On average, the brand could represent about half of sales at company-run stores. Currently, Billabong represents about 20 percent of sales in West 49 stores.
The company's takeover campaign boosted the number of DOS to 635 at the end of December from 380 on June 30. They contributed about 40 percent of the group's revenues and generated an Ebitda margin of 13.6 percent, against 14.9 percent at constant currency rates a year earlier.
The group is selling the existing and ordered inventories of acquired retailers at lower margins than its core business. It expects margins to pick up in the second half as inventories are cleaned up. Nevertheless, the DOS' Ebitda margins were on the rise during the first half in all geographies except in Australia, New Zealand and Asia, where they fell to 18.0 percent from 24.4 percent. They rose to 9.0 percent from 3.5 percent in North America; to 18.7 percent from 12.1 percent in South America; and to 14.5 percent from 10.4 percent in Europe.
The company said its stronger presence in retail will enable it to be more reactive in seizing changing consumer moods. O'Neill noted that they changed significantly between the beginning and the end of the Australian summer season. West 49, along with the Two Season stores in the U.K., is also seen as an opportunity to increase sales of winter sports goods. Acquired expertise in that segment could be spun off to Billabong stores in locations such as New York. No further acquisitions are planned except for small-sized retailers in Australia, where the group already has 130 stores.
The debt/equity ratio increased to 24.6 percent from 14.4 percent because of the acquisitions. Dragged down in part by higher interest charges, Billabong's first-half net profit fell by 18 percent to A$57.2 million (€42.0m-$58.0m). In constant-currency terms, the bottom line declined by 10 percent. The Australian dollar gained against its U.S. counterpart during the fiscal half year, reaching a record on Dec. 31 and crimping North American earnings. Without the currency impact, profit would have been A$6 million higher, Billabong said.
The management warned in December that first-half net profit would fall by 8-13 percent in constant-currency terms. It will pay an interim dividend of 16 cents, down from 18 cents a year earlier.
For the full financial year, sales should go up by around 25 percent on a currency-neutral basis and reach A$1.7 billion (€1,247m-$1,722m). Earnings are expected to be flat in constant currency terms, but they may fall by about 10 percent in reported terms based on current trading and exchange rates, Billabong said. From the next fiscal year, the group expects profits to return to an annual growth rate of more than 10 percent at constant currency rates as it begins to generate more “vertical” margins through its retail operations.
