It's worth digging into Pumpkin Patch

By JENNY RUTH

Another commentator has suggested we are nearing the end of a bull market with one piece of evidence the plethora of floats of plummeting quality.

Although some of the recent offerings are of dubious quality, that is emphatically not the case with the Pumpkin Patch float.

This is a company with a very strong brand, a strong market position in a niche with little competition, and an extensive track record in increasing store numbers, sales and profitability.

Moreover, unlike some other major retailers, its growth prospects are readily apparent.

While other recent floats have clearly represented an exit strategy for venture capitalists, this motive seems a secondary one for Pumpkin Patch's promoters who want to repay debt and fund expansion.

If fewer than 60.8 million of the just over 81 million shares on offer are sold, the company can refund any of the proceeds above $40 million and not repurchase any of the up to 49 million or so existing shares offered by selling shareholders. The offer isn't underwritten.

None of the existing shareholders are seeking to sell out entirely. If all shares are sold, the largest shareholder, Feruza Trust, will see its stake go from 36.3 per cent to 14.6 per cent.

Key personnel, including founder Sally Synnott, managing director Maurice Prendergast and design and marketing director Chrissy Conyngham, are selling relatively small parcels of shares.

Prendergast has put three million shares up for sale and will retain 13.4 million. Synott is selling 700,000 shares and keeping 10.4 million. Conyngham is selling just over 1.5 million shares.

Once the float has been completed the existing shareholders will be barred from selling for 12 months.

If all shares are sold, new shareholders will own 48.7 per cent of the company, suggesting that promoting liquidity may have been a factor in existing shareholders deciding to sell some of their holdings.

The longevity of management should be of significant comfort to investors. Prendergast and Conyngham have been with the company since 1993, as has Bruce Walkley, currently business development manager for Europe.

The one sticking point for the institutions, whose bidding will help establish the final price to be paid for the shares, may be the indicative asking price of between $1.20 and $1.40 a share.

At those prices, the promoters are asking between 17.4 times and 20.3 times this year's earnings and between 13 times and 15.2 times next year's earnings.

Comparisons with other similar recent floats make this look somewhat ambitious. Pacific Brands, for example, aimed for A$2.25 and A$2.60 ($2.55 to $2.95) a share or 11.5 times to 13.3 times 2005 earnings. In the event, the shares were sold at A$2.50 and were trading on Thursday at A$2.49.

Even more ominous, Just Group sought between A$2.25 and A$2.70 a share. At A$2.60 a share, that would have been 13.5 times 2005 earnings before goodwill amortisation. In the event, the company had to accept just A$2.10 a share. Subsequent trading suggests even that was too rich: as the shares were trading at A$1.95 on Thursday.

Comparisons with listed New Zealand retailers also suggest Pumpkin Patch may be asking too much.

Briscoe Group is currently trading at 10.3 times expected earnings for the current year and Hallenstein Glasson Holdings is trading at 13.4 times expected earnings for the year ending July 2005.

The Warehouse Group is trading at 13.6 times expected earnings for the year ending June 2005 and Michael Hill International at 15.1 times expected earnings.

Given that Briscoe is going through a difficult patch and that Pumpkin Patch and Michael Hill have both been successful in Australia, you can easily argue that Pumpkin Patch's pricing should be closer to Michael Hill's than to Briscoe's.

Then there's the issue of how believeable are the forecasts that the indicated price-to-earnings ratios are based on.

The company is forecasting that earnings before interest, tax, depreciation and amortisation (ebitda) will jump from $16.7 million in the year ended July 31 last year to $26.7 million this year.

While that's a 60.4 per cent increase, you would have to think that, so close to balance date, the directors must be pretty sure the bulk of these profits are already in the bag.

It is forecasting a more modest 16.8 per cent increase in ebitda to $31.2 million for the year ending July 31, 2005.

But the company does have an established track record: the 2003 ebitda increase was 18.2 per cent and the 2002 increase was 27.7 per cent, so the forecast rate of growth for 2005 is slower than in any of the previous four years.

So it isn't that hard to argue that the high price-to-earnings multiples being asked are justified.

But another way of looking at it is to compare historical and expected profit margins. In 2001, the company's ebitda profit margin was 7.3 per cent of sales. That rose to 8.1 per cent in 2002, 8.6 per cent in 2003 and is expected to jump to 12.5 per cent this year. The forecast for 2005 is 12.6 per cent.

As one fund manager says, Hallenstein Glasson is regarded as among the best clothing retailer in New Zealand and its best ever profit margin has been a little over 12 per cent. Pumpkin Patch's promoters are suggesting they can do better than that.

The prospectus shows the company's store numbers have gone from one in 1992 to 111, with another two due to open in New Zealand before July 31.

This means it will have added 29 in the current year. It is forecasting only nine new stores for 2005.

Part of the reason for the jump in stores this year is its purchase earlier this month of the 14 HBK Girl stores. The company's forecasts don't include any contribution from these stores.

For the current year, the company expects 64 per cent of sales will come from its 64 Australian stores and 21 per cent will come from its New Zealand stores, which will total 39 by July 31. A further 3 per cent of sales will come from direct catalogue sales in Australia and New Zealand and a further 2 per cent will come from wholesale sales to other retailers in these countries.

Even if you take the view that the company already has the maximum number of stores New Zealand's population can support, there seems plenty of room for extension in Australia, a market five times larger the size. That suggests there's room for at least 200 stores in Australia.

The company's forecasts are based on its potential in Australia and New Zealand, but it also has potential overseas.

It already has 10 stores in Britain which are expected to contribute 7 per cent of 2004 sales.

At present, the company's British stores are a drag on profitability. They made a $2.6 million ebit loss in 2003 and are forecast to lose $2.5 million this year and $2.4 million in 2005.

The company has already proved its success at building up critical mass in both New Zealand and Australia - it opened its first store there in 1997.

The prospectus doesn't forecast new store openings in Britain, but you would expect to see at least some, since greater store numbers are obviously the key to making such operations profitable.

Wholesale sales in Europe and the US will contribute the remaining 3 per cent.

Pumpkin Patch already supplies 10 international department store retailers of whom the largest are Nordstrom in the US, David Jones in Australia and Roches in Ireland.

These retailers display Pumpkin Patch merchandise either as a "store-within-a-store" concept, or on racks surrounded by the company's branding.

The company will have plenty of balance sheet capacity to fund expansion if the float proves to be successful.

The prospectus forecasts shareholders' equity at $64.6 million at July 31 and total assets at $85.5 million.


PUMPKIN PATCH

* Started life as a one-store, mail-order children's clothing firm in 1990.

* Now a 111-store New Zealand success story, with internet sales and shops in Australia, Britain and a supplier to big name retailers such as Nordstrom in the US.

* The IPO seeks to raise between $97 million and $113 million in its 81 million share offer, then list on the Stock Exchange.

* If it lists, the stock exchange will have a new top 50 company which employs about 1700 staff around the world. Nearly 70 per cent of staff work part-time.