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Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>KMD Brands<br>1H22&nbsp;— Waiting For a Break</h2>
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<p><strong>OUTPERFORM</strong></p>
<p>KMD Brands' (KMD) 1H22 result delivered little surprises and we continue to see value in the company's long-term strategy. The ~-$6m&nbsp;NPAT loss was in line with ours and the market's expectations. The result is largely inconsequential, with pandemic restrictions and supply chain delays preventing any insight on the new level of normalised earnings for the business following the Rip&nbsp;Curl acquisition. Looking through short-term disruptions and trading on a two-year forward PE of&nbsp;~10x on our earnings estimates, we view the current valuation as an attractive entry point for a company with enhanced channel diversity, reduced seasonal risk and international growth aspirations. We remain OUTPERFORM rated.</p>
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<h3>What's changed?&nbsp;</h3>
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<li><strong>Earnings</strong>:&nbsp;We reduce our FY22 to FY24&nbsp;NPAT&nbsp;estimates, predominantly reflecting higher depreciation costs</li>
<li><strong>Target price</strong>:&nbsp;Trimmed to NZ$1.60 from NZ$1.65 as a result of our reduced earnings assumptions</li>
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<h3>1H21 result provides limited new information</h3>
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<p>With management's guidance issued after the period end&nbsp;new information was in the detail. Rip&nbsp;Curl's&nbsp;+16% wholesale revenue growth highlighted&nbsp;the benefits of channel diversity&nbsp;with total sales up +3%.&nbsp;Kathmandu's&nbsp;total sales were down&nbsp;-35% on pre COVID levels, with a ~+15% increase in lost trading days on 1H21. Incremental marketing spend (NZ$14m in 1H22) is expected to be more weighted to the first half with total marketing expenses over time expected to comprise&nbsp;5%–7% of sales.&nbsp;Gross margins were ~58%, down -130bps on 1H21 due to elevated freight costs and a higher clearance mix for the Kathmandu brand. The fully franked 3cps interim dividend was ahead of our expectations.</p>
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<h3>Healthy balance sheet with elevated inventory to mitigate supply chain delays</h3>
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<p>KMD remains well capitalised. Net debt at period end was ~NZ$50m with an additional NZ$250m funding headroom. Whilst the business has capacity for M&amp;A opportunities we expect the focus will remain on integrating its current brands. Inventory levels were +9% on 1H21, primarily to mitigate supply chain delays. Inventory levels are seasonally higher in the first half to support Kathmandu's winter sales and Rip Curl's North American summer sales, but elevated levels will raise the risk of greater discounting activity.&nbsp;</p>
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<h3>Outlook remains uncertain but we expect conditions to begin gradually normalising</h3>
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<p>While no FY22 earnings guidance was provided, forward order demand for Rip Curl and Obõz products remains at record levels. 2H22 gross margins are expected to be in line with 2H21 (~59% at the group level).&nbsp;Management also noted that&nbsp;Kathmandu inventory&nbsp;is well positioned for its key winter period (historically ~75% of FY EBIT). We expect reduced&nbsp;COVID restrictions and the resumption of travel will support the initial recovery of the brand's sales during 2H22.&nbsp;</p>
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KMD Brands 1H22&nbsp;— Waiting For a Break

OUTPERFORM
KMD Brands' (KMD) 1H22 result delivered little surprises and we continue to see value in the company's long-term strategy. The ~-$6m&nbsp;NPAT loss was in line with ours and the market's expectations. The result is largely inconsequential, with pandemic restrictions and supply chain delays preventing any insight on the new level of normalised earnings for the business following the Rip&nbsp;Curl acquisition. Looking through short-term disruptions and trading on a two-year forward PE of&nbsp;~10x on our earnings estimates, we view the current valuation as an attractive entry point for a company with enhanced channel diversity, reduced seasonal risk and international growth aspirations. We remain OUTPERFORM rated.


What's changed?&nbsp;



Earnings:&nbsp;We reduce our FY22 to FY24&nbsp;NPAT&nbsp;estimates, predominantly reflecting higher depreciation costs
Target price:&nbsp;Trimmed to NZ$1.60 from NZ$1.65 as a result of our reduced earnings assumptions



1H21 result provides limited new information


With management's guidance issued after the period end&nbsp;new information was in the detail. Rip&nbsp;Curl's&nbsp;+16% wholesale revenue growth highlighted&nbsp;the benefits of channel diversity&nbsp;with total sales up +3%.&nbsp;Kathmandu's&nbsp;total sales were down&nbsp;-35% on pre COVID levels, with a ~+15% increase in lost trading days on 1H21. Incremental marketing spend (NZ$14m in 1H22) is expected to be more weighted to the first half with total marketing expenses over time expected to comprise&nbsp;5%–7% of sales.&nbsp;Gross margins were ~58%, down -130bps on 1H21 due to elevated freight costs and a higher clearance mix for the Kathmandu brand. The fully franked 3cps interim dividend was ahead of our expectations.


Healthy balance sheet with elevated inventory to mitigate supply chain delays


KMD remains well capitalised. Net debt at period end was ~NZ$50m with an additional NZ$250m funding headroom. Whilst the business has capacity for M&amp;A opportunities we expect the focus will remain on integrating its current brands. Inventory levels were +9% on 1H21, primarily to mitigate supply chain delays. Inventory levels are seasonally higher in the first half to support Kathmandu's winter sales and Rip Curl's North American summer sales, but elevated levels will raise the risk of greater discounting activity.&nbsp;


Outlook remains uncertain but we expect conditions to begin gradually normalising


While no FY22 earnings guidance was provided, forward order demand for Rip Curl and Obõz products remains at record levels. 2H22 gross margins are expected to be in line with 2H21 (~59% at the group level).&nbsp;Management also noted that&nbsp;Kathmandu inventory&nbsp;is well positioned for its key winter period (historically ~75% of FY EBIT). We expect reduced&nbsp;COVID restrictions and the resumption of travel will support the initial recovery of the brand's sales during 2H22.&nbsp;


Kathmandu Holdings

KMD Brands: 1H22 — Waiting For a Break