@Menza, Excellent rebuttal, thanks for making it. As your post...

@Menza,

Excellent rebuttal, thanks for making it.

As your post has highlighted, my analysis is really legacy-focused, while yours attends to what could transpire in the future (which is what ultimately will drive the market's pricing of the company), if the turnaround efforts are successful.

As I've found, the operating leverage in this business is huge; therefore if they do manage to turn things around, the earnings recovery will be explosive.


Your 10-point argument for the bull is also very well-made, I thought. Just a few comments I'd take the liberty of adding.

1. Cotton On 20% stake - I can't help but think there will eventually be a takeover by Cotton On Group

You might be right ultimately, but I think that investing on the basis of takeover potential alone is not a very sustainable way to invest. But judging from your comments, I know that the takeover prospects are of subordinate interest to you, and that your primary focus is on the turnaround prospects. So my cautionary comments about takeover appeal are probably more general in nature.

(As an asides, I note that the company has some $44m (23cps) in franking credit balance, which might have appeal to a corporate acquirer, although I've never known any corporate acquisition to take place solely for the franking credits of the target company0

2. Revenue has been climbing for quite some time

Yes, this I noticed. But much of the Revenue growth has been profitless. SFH's Market Cap-to-Sales Revenue is just 0.12 times, which is incredibly low.

I can count on my one hand how seldom I've come across such a low figure. Which is what compelled me to doing some deeper analysis on the company in the fist case. This means that the cost base (both CoGS and CoDB) is very high, so slicing just a slither off CoGS and/or CODB will result in a significant improvement at the operating profit line.


3. For a retailer, debt is well managed, as is cash flow

Here I differ with you. SFH's off-balance sheet liabilities are significant; Capital and operating lease commitments totaled a whopping $186m @ 30 June 2016, albeit down from $233m at the end of the previous year, so it looks like cull of the poorer performing stores in the portfolio had already started some time in 2016, with the financial results still to become manifest in the results.

Still, given the nature of the leasing model, from a risk management point of view, a business like SFH should never be run with any meaningful borrowings, I don't believe. (NIBD-to- EBITDA of 2.0x is way too high... if anything, this sort of cyclical and capital intensive business, with its significant contingent liabilities, should be run on a net cash basis, in my view.)

The magnitude of the off-balance sheet liabilities explains why the company has had to cut dividends in 2005, 2006, 2009, 2012, 2015 and 2016, even when the debt appeared to be well-managed at the time.


4. The last couple of years' performance has been hampered by the Rivers acquisition, which was always going to be risky

Point taken. Rivers appears to me to be a good brand at one point in time.

However, the performance of Rivers doesn't seem to do justice to my perception of its brands.

So Rivers is a bit of a worry for me.

Yes, they only paid $5.0m for the business plus up to $27m of working capital financing, but it feels to me a bit like they have been throwing good money after bad since they bought it in 2013.

At the time of purchase, Rivers was making 5% EBITDA margin on $180m of Sales. SFG management claimed at the time that they could add $6m of EBITDA from net cost savings. That implied an EBITDA run rate of $15m, or an EV/EBITDA acquisition multiple a little over 2 times, which looked quite attractive.

However, it hasn't quite panned out that way because, fast-forwarding to 2015, and Rivers was still making EBITDA losses, as it was in FY2016, as well. And in the interim, SFG management have basically had to re-start a lot of the Rivers business aspects (inventory management, procurement, critical path management, ranging, re-staffing at senior level, marketing strategy, supply chain management, store format and fixtures), from scratch.

In 2015, management indicated Rivers would be profitable in 2016. Now they are saying it will be profitable in 2017.


5. Brands are all recently rejuvenated, Millers in particular

Noted. I just hope that the consumer has enough confidence to respond accordingly.


6. Online sales are quite strong for a retailer targeting older women (9%)

Noted.


7. Well known brands, millions of customers on email lists

Noted.


8. USA and UK expansion - for me this is key. Australia is a limited market and growth is capped.

Noted. Although I also note that the road is littered with the carcasses of companies going offshore to make their fortune (especially when it is done in an attempt to compensate for an under-performing domestic business... not that i am necessarily saying this is the case here).

For me this international foray is actually a potential negative given it might prove to be a distraction from the attention their domestic business needs in order to be fixed.


9. Management are heavily invested, and are long term operators

For me, this, more than anything else, is key.

The guys running this company own almost half the issued capital of the company. Also, I think these guys are good rag trade operators.
They are certainly good stewards of shareholder capital, I reckon, having never done anything too dumb on that front. (I hope Rivers doesn't end up being the first major misstep for them.)

Trouble is, as managers, while they might score 9 out of 10, they are running what I see as a 6 out of 10 business, which operates in an external business environment currently running at just 3 out of 10.


10. Store network is huge, for $100m market cap and over 1,000 stores is remarkable.

Yes, this is another critical aspect of the company, but for a different reason that you might be suggesting.

Because like all retailers running massive store networks like this, the Pareto Principle applies, whereby the 20% top-performing stores generate 80% of the group's Gross Profit, and where there is a tail of under-performing stores that make losses.

I'm not sure what the tail of SFG's store base look like, but when you have $830m of Sales being generated by over 1,000 stores, that averages out to just $800k per store per annum. And given some of the best stores will be selling in the millions of dollars per annum, there are sure to be a reasonable number of stores that are doing just a few hundred thousand dollars of sales per year, and there is no way that sort of revenue base can be profitable given the fixed cost overhead that would be involved.

I'm just guessing here, but if you chopped off the bottom 10% or 15% of the poorest-performing stores (which, given the 20% reduction in their 2016 vs 2015 rental lease liabilities in 2016 vs 2015, looks like has started to some degree), I suspect that the resulting financial impact will not be immaterial.



Thanks for the meaningful engagement and exchange of views on SFH.
I certainly learnt something as a result of it.
I hope others did, as well.

Many participants on this forum don't take kindly to having to consider views that are not perfectly aligned with their own, and that reinforce their personal biases.

It is a credit to you that you are happy to take into account less-than-positive commentary and analysis on a stock in which you have invested.

Good luck your investment.

Because it looks so very cheap, I haven't given up on the company quite yet, and will be studying the upcoming interim result in some detail.