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Morningstar | Premier Investments' Revises Smiggle Growth Target as Brexit Bites. AUD 14.50 FVE Unchanged

No-moat-rated Premier Investments' sales growth in the first half of fiscal 2019 was broadly in line with our expectations, but the composition of the sales growth was a surprise. The core apparel brands, which have been losing market share for years, came roaring back. However, this outstanding result was largely canceled out by materially weaker sales growth of the key Smiggle brand. The slow-down in Smiggle’s sales growth outside of Asia was to such an extent management pushed out its aspirational fiscal 2020 sales target for the children’s stationery chain by 1.5 to 2.5 years. We’ve adjusted our near-term sales growth estimates for the apparel brand and Smiggle, resulting in an immaterial change in to our full-year fiscal 2019 earnings estimate. However, we have tapered Smiggle’s sales growth trajectory, which was partially mitigated by a more favourable longer-term outlook for the core apparel brands. The net negative impact of these changes on our intrinsic valuation were offset by lower capital expenditure, the time value of money and a higher valuation attributed to Premier’s 28% ownership of ASX-listed Breville Group. Our fair value estimate is maintained at AUD 14.50, with shares screening as overvalued at current prices.

We had expected Brexit uncertainties to weigh on retail spending in Smiggle’s largest market, but the impact on the brand’s sales growth has been much more pronounced than we anticipated. British consumer confidence was at a five-year low in January 2019, and only marginally improved to 104.7 in February 2019 from 104.3. We had forecast Smiggle’s overall sales to increase by 22.8% in fiscal 2019, but due to the poor performance of the brand in the first half we cut our full-year sales growth estimate to 4.6%. This is broadly in line with the 4.8% growth achieved in the first half, which includes Christmas and hence dominates full-year sales results.

We estimate Smiggle’s sales growth was slightly negative outside of Asia--its Asian market consisting of Singapore, Hong Kong and Malaysia remained very strong with sales growth of 35%, but accounts for just about one fourth of our Smiggle sales estimate for fiscal 2019.

Smiggle’s mixed result highlights the benefits of further diversifying the brand into new markets to keep the growth story alive. The move towards a more capital-light expansion strategy of combining wholesaling and concession opportunities, as well as greater exposure online, conserves funds and mitigates the exposure to long-term lease commitments. We estimate the wholesaling margin at 13%, slightly higher the 12.7% EBIT margin of Premier’s Retail segment in fiscal 2018. However, we estimate the contribution of Smiggle’s wholesaling revenue at only half of the associated retailing revenue. Therefore, twice the volume of products must be sold to generate the same sales for Premier. We expect 100 partnering stores to be supplied from early fiscal 2020, but these partnerships to result in 15% lower sales for Smiggle in fiscal 2020 than we had previously estimated. We expect Smiggle to generate AUD 462 million in revenue by fiscal 2022. This is down 30% from the AUD 658 we had previously estimated based on a company-owned store roll out strategy. Management now targets AUD 450 million in sales from Smiggle by calendar year 2021 or 2022, versus fiscal year 2020 previously. The adverse impact of slower sales growth resulting from the wholesaling strategy is offset by significant cost savings. We lowered our capital expenditure estimates by 30% on average over the next decade. We note, the simultaneous expansion into six new countries as a wholesaler offers sizable market share gains, but also bears the risks of overextending management.

Smiggle’s intention to sell on Amazon’s platforms in Europe and launch a transactional website in New Zealand in the second half of fiscal 2019 provides more exposure to consumers and potentially additional sales. However, consumers in both markets are already serviced by Smiggle websites in the U.K. and Australia. We expect sales on Amazon in Europe and the company-owned New Zealand website to cannibalise sales on the existing platforms. We estimate Smiggle sold AUD 7 million of merchandise into continental Europe via its U.K. website in fiscal 2018.