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Morningstar | Samsonite Faces Prolonged Consumer and Tariff Weakness, Uncertainty Heightened, FVE Cut. See Updated Analyst Note from 14 May 2019

As we expect the U.S.-China Trade War to be prolonged, we lower our base-case assumptions to reflect lower sales and reduced operating margins. Our uncertainty rating is raised to very high from high and our fair value estimate is cut to HKD 27 from HKD 34. The adoption of IFRS 16, which adds around USD 200 million to amortization, lowers Samsonite’s reported operating profit but has no impact on our cash flow forecasts. Nonetheless, the combination of the accounting change and our reduced growth assumptions results in an average 30% reduction in our net profit forecasts and 16% to our free cash flow. Because we see the current headwinds as largely cyclical, we keep our narrow moat rating. We think Samsonite’s current share price already reflects the risk of added tariffs but the ongoing uncertainty will weigh.

Inventory restocking is likely to boost sales next quarter, but we expect the travel segment to be lacklustre for the rest of 2019. We think the risk of another round of tariff hikes is real given the deterioration in trade talks. As a result, our base case assumes flat sales in 2019 followed by a slow recovery in 2020, which is closer to our original bear case scenario. Samsonite management sees a recovery in sales despite the tariff risk as they believe their wholesale customers have already adjusted inventory levels to account for the risk of reduced demand. Also, the company appears to have been able to shift production out of China more successfully than we thought and if it does hit 70% ex-China sourcing by year-end, the tariff impact may be largely nullified.

First quarter sales fell 2.4% (constant currency basis), although weak wholesale purchases in the U.S. and continued drops in China’s corporate sales were expected. Timing factors with costs related to new stores raised distribution costs as a portion of revenue leading to a 300 basis point reduction in operating margin. As a result, net profit fell 48% year-over-year.

Because of the likely pick up in sales, Samsonite still expects to meet its inventory turnover days by year-end. We have kept this assumption unchanged. The first quarter is traditionally its weakest quarter and given the lack of promotions unlike its Ronaldo and American Tourister campaign last year, the drop in growth was noticeable especially in its European and American Tourister sales. The ongoing “yellow jacket” unrests in Paris also continue to hurt sales there.

China is expected to see continued spending constraints as we think the trade talk uncertainty will lead to a prolonged slowing in discretionary spending. The portion of corporate sales as businesses cut promotions will probably see growth ease to the low-single digits in Asia. However, Tumi is relatively resilient, still posting 8.5% growth in sales globally and is especially strong in Asia at 17% and Europe at 22.5%. This reflects in part the low base that Tumi had outside of the U.S. and the benefits from an increased retail reach. These new stores added in 2018 have heightened the portion of distribution costs in the first quarter relative to sales. We expect this to even out over the rest of the year so we forecast operating margin to improve to 9.8% for the full year 2019 from the 7.1% in the first quarter. However, this will still be lower than the 12.6% in 2018 due in part to the adoption of IFRS 16.

Although our free cash flow is lowered, it is still positive and the company remains in a comfortable financial position with the flexibility to lower capital expenditure if needed. We think net gearing should decline to 0.69 times in 2019 from 0.77 times in 2018. Lower interest expense following last year’s debt refinancing will help.