Fat Prophets updates Billabong International recommendation
Two major variables are driving Billabong International’s (ASX: BBG) current stock price performance, both of which will prove the primary determinants of future earnings.
These are of course the relative strength of the Aussie dollar and the recovery or otherwise of the retail sector, particularly in the US. Concerns on both these fronts are presently weighing on investor sentiment for the stock.
Management has however done an excellent job in protecting the brand through the cycle. Indeed, the company continues to offer attractive exposure to the longer-term US recovery and we view the stock’s current price weakness as an attractive buying opportunity.
CEO Derek O’Neill provided some positive commentary at the company’s recent AGM. With regards to the US, he stated that retail conditions seem to have bottomed out.
He based his views on the performance of Billabong’s company owned stores.
The real litmus test will be whether similar strengthening becomes apparent through the core wholesale business. Given the recent strong GDP and manufacturing data coming out of the US (see this week’s market comment for details), we believe this is likely to be the case.
Looking beyond the US, management reported that Australasia is “tracking generally as expected”. Management’s tone would have been stronger were it not for weaker conditions in Japan, New Zealand and South Africa, which offset a robust environment here in Australia.
With Europe also generally in line, management did not adjust their previous guidance for 5% earnings growth. This is however on a constant currency basis, which ignores the effect of exchange rate movements on Billabong’s Aussie dollar denominated earnings.
Constant currency accounting is a useful tool, in that it provides a clearer picture of management’s operational performance.
The bottom line remains however that the company’s Aussie dollar earnings drive its valuation and the currency’s current strength is a significant headwind.
In terms of the actual impact of exchange rate movements, management revealed that each 1 cent movement from 92 cents against the US dollar impacts Billabong’s earnings to the tune of A$500,000.
Although the European region makes a smaller contribution than the US to group earnings, each 1 cent move in the euro equates to a $1 million bottom line impact.
The disparity is due to the movement representing a bigger percentage change for the euro, which is currently around 61 cents.
The table below shows our estimation of the sensitivity of Billabong’s 2010 Aussie dollar denominated sales and earnings to various US dollar and euro valuations.
The currency valuations on the bottom row correspond to the averages recorded during 2009. We have applied conservative sales growth rates for the coming year of 5% for Australia and Europe, and 0% for the US, measured in local currency values.
