On M&A, management seems to have again begun to warm up to such an option compared to five months ago: this probably reflects a degree of management comfort that the measures required to combat this downturn are either in place or put in motion, hence freeing up senior management attention, and meanwhile some possible distress sale opportunity as the downturn progresses.
On whether a new strategic shareholder may be forthcoming, management‘s stance remains that: 1) it does not need cash (we add: unless it identifies a sizeable use of cash, like M&A), 2) it is not worried about any new shareholder interfering with its operations or direction, as it does not see itself as an underperforming or pressured business and 3) as a publicly listed company, management cannot choose its shareholders who bought and sold on the open market.
Admittedly, these results were nothing to write home about but what also stood out was what CEO Heinz Krogner called the —inner strength“ of Esprit even amid the tough trading environment: group SSS was +6.3% in constant currency, led by a remarkable +6.9% in Europe (against peers‘ performance of -2% to -6% and well ahead of the ~+2% we were expecting). With what seems only a relatively modest sacrifice in retail G.M., the only explanation for this performance must be: 1) Esprit‘s loyal customers and Esprit‘s —intense“ customer nurture programme to bring repeat business and a higher conversion rate amid pressured footfall across the industry, 2) the desirability of Esprit‘s products in its core markets (its currentrevenue growth challenge is more a function of its wholesale channels and currency translation, not a broken product) and 3) its diversified product-price repertoire, which continues to give it the opportunity to pick up down-trading from higher-end brands œ its women‘s Esprit Collection division, at +6.7% YoY in HKD terms, was the second fastest growing line, second to edc men at +28% YoY (but about half the scale). Esprit women casual was flat.
We believe management has a good grasp of its core competencies, and hence its tactical response to this downturn has been to: 1) quickly streamline on product offering to focus on strong sellers (elimination of peripheral products is expected to yield a significant reduction in production and attendant savings, plus better merchandising accuracy and focus), 2) focus on delivering better quality products and price-value proposition. We believe these have already begun to produce results (witness its SSS). Longer-haul, its ongoing efficiency optimisation includes a new distribution centre in Germany, which it believes will reduce processing costs per unit, and investing in an advanced retail IT system that it expects to enhance its stock control and save on mark- downs. With a still very cashed-up balance sheet (HK$3.8 bn cash, even after paying an earlier HK$4 bn dividend, zero debt), Esprit has the luxury to continue to invest in more sophisticated back-end and new stores (retail space is budgeted to grow 12% YoY this year, of which 10.9% was already booked in 1H FY œ although Esprit is definitely becoming more careful on committing: focusing only on strong core markets and eschewing the heavy upfront investments from entering new markets: further expansion in Spain put on ice; the Madrid and Barcelona flagship stores in hindsight proved inopportune in timing), while continuing with a fairly respectable dividend payout (payout ratio unchanged YoY but DPS naturally trimmed), and even entertain the option of M&A. Even on North America, there seems little pressure at this point to rein in the annual US$40 mn loss budget œ the North America strategy is obviously being reviewed now in light of management changes there and a new incoming President of North America (identified but yet to be named in public), and CEO Heinz Krogner admitted that Esprit‘s next operational challenge is to find a formula to establish itself in new markets faster. However, North America is still in investment mode for Esprit, and while it is unhappy about the —loss to growth ratio“, its agenda there is to explore a way to grow faster the next three years at the same US$40 mn p.a. loss budget, rather than saving some of that US$40 mn œ as management still believes it can afford that investment comfortably.
Finally, on whether a new strategic shareholder is forthcoming (the press has been mentioning the Gunter Herz-controlled Mayfair GmbH [not listed]), Esprit management‘s stance remains that 1) it does not need cash (we add: unless it identifies a sizeable use of cash like an M&A), 2) it is not worried about any new shareholder interfering with Esprit‘s operations or directions as it does not see itself as an underperforming or pressured business, and 3) as a publicly listed company, management cannot choose its shareholders who bought and sold on the open market. It is futile to conjecture at this point except monitoring developments, and if Mayfair indeed purchases some shares, we take it as an endorsement that someone also thinks Esprit‘s current single-digit P/E undervalues the stock.
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