Stock Takes: Tough times for Kathmandu

Heavy discounting required to clear excess stock would result in a first-half loss of $1 million to $2 million. Photo Natalie Slade

Discounting makes lifting margins harder.

Kathmandu's profit warning this week was a shocker, there's no doubt about it.

The revelation that heavy discounting required to clear excess stock would result in a first-half loss of $1 million to $2 million knocked more than 26 per cent off the outdoor retailer's share price, which closed at $1.47 on Monday, the day of the announcement.

But the extent of the sell-off was pretty extreme given the second half of Kathmandu's financial year - when its Easter and winter sales take place - is of far greater importance than the first.

As acting chief executive Mark Todd pointed out on Monday, 70 per cent of profit was earned during the second-half last year.

We've been here before.

Just before Christmas 2011 the company released a downbeat trading update, warning that first-half earnings would be lower than the same period a year earlier.

Investors ran for the door and Kathmandu's share price plunged 25 per cent on the day of the announcement to close at $1.64. And the declines continued until the stock reached an all-time closing low of $1.27 on June 29, 2012.

There were a few hiccups along the way, but from June 2012 onwards its shares made relatively steady gains, on the back of improving financial results, until they reached a record close of $4 in May last year.

Since then a string of disappointing trading updates has wiped 65 per cent off the retailer's share price, which closed down 1c yesterday at $1.39.

Same cycle?

Could Kathmandu be going through a similar cycle to the sell-off and subsequent rallies that took place between 2011 and early last year?

The New Zealand Superannuation Fund may have taken that view.

It boosted its stake in the company last Friday by one percentage point to just over 6 per cent. Obviously that was prior to the profit downgrade, but the fund must have done a bit of work on the stock and taken the view that it was undervalued, even before its latest slump.

"For our part, the fund is a long-term investor and we are attracted to Kathmandu's long-term story," a spokeswoman said this week.

Aussie fund manager Tribeca Capital Partners and local firm Harbour Asset Management are taking a different approach, reducing their stakes in the retailer from 5.7 per cent to 3.6 per cent, and from 5.2 per cent to 4.6 per cent respectively.

Going into loss-making territory is serious, and Kathmandu is going to have to significantly improve its gross margins during the second-half, which is unlikely to happen if the same levels of discounting continue.

Bull market for fancy burgers

United States-based burger chain Shake Shack shares more than doubled on their first day of trading in New York last Friday, closing at US$45.90. Photo / Bloomberg

For similar companies, Shake Shack and BurgerFuel have remarkably different market values.

Shake Shack shares more than doubled on their first day of trading in New York last Friday, closing at US$45.90, giving the business a market capitalisation of about US$1.6 billion.

That makes the roughly $209 million valuation of Auckland-based, NZAX-listed BurgerFuel - which operates a larger number of stores than its US counterpart and is on a similar growth trajectory - appear modest in comparison.

BurgerFuel shares closed down 5c yesterday at $3.50.

Shake Shack, which raised $105 million through its IPO, posted total revenue of US$83.8 million for the first three quarters of 2014, with net income of US$3.5 million.

BurgerFuel reported total sales of $38.6 million and net profit of $213,215 for the half-year to September 30, 2014. The company's profit line is irrelevant at the moment as it's in the midst of a major growth push.

Shake Shack's initial public offering certainly gave the company a head start. The Manhattan-based firm's shares were priced in the IPO at US$21 each, valuing the company at US$751 million before the stock began trading.

The float was aided by fast-casual dining chains, which are eating into the profits of mainstream fast-food players like McDonald's, and becoming increasingly in-vogue with investors.

Bob Goldin, executive vice-president at foodservice consultancy Technomic, told Reuters that Shake Shack would need to pull off "explosive growth" for many years to justify its share price.

Close rivals

Auckland-based, NZAX-listed BurgerFuel - operates a larger number of stores than its US counterpart.

Shake Shack happens to be one of BurgerFuel's main competitors in the Middle Eastern fast-casual restaurant market and will become an even bigger rival after the New Zealand company launches in the US.

It operates 63 stores, of which 31 are company-owned outlets based in the US. It has 32 franchised sites, with 27 of those located in international markets including the United Arab Emirates, Kuwait and Britain.

BurgerFuel has 69 stores, of which 39 are New Zealand-based with the remaining outlets spread across Australia and the Middle East. Only two of its restaurants are company-owned, although the firm has plans to buy back franchise-owned stores.

The traditional metric of price-to-earnings ratio suggests the New Zealand firm's valuation could be more stretched than Shake Shack's.

BurgerFuel has a PE ratio of 396.5, according to NZX data, while Reuters said Shake Shack, based on 2013 data, had a PE of about 325 on its first day of trading.

A large chunk of BurgerFuel's valuation is based on the company's plans to use its partnership with the founders of the Subway sandwich chain to enter the US market.

With the fast-casual dining sector becoming a hot investment area, it will be interesting to see where the share price goes if the company begins executing its North American expansion and, potentially, attracting the attention of investors in that part of the world.