Emerging value, momentum building

The result was quite strong. Positively changes my sentiment and view on outlook for several reasons.

The market's key concerns have been Rivers turnaround and the threatening impact of the strengthening USD/weakening AUD.

Currency movements did hit the result considerably; the gross margin reduction in the '16 first half of 3% on constant sales reduced gross profit by some $12m, inclusive of the partial offsetting effect of savings from initiatives such as continued growth in direct sourcing. The reduction to gross profits is huge when pretax 'annual' results are expected to be around $10m for 2016. Sales growth mitigated gross profit reduction by some $7m for the half. Additionally, cost of doing business savings provided another $3m contribution (suspect Company Secretary departure announced today part of cost reduction initiatives) leading to a small underlying EBITDA pcp reduction for the business, excluding Rivers, of around $1.2m. Not bad given recent circumstances with currency.

All eyes on cotton prices; USD pound prices approximately 15% below where they've been over last few years, closing round $US 58 recently, assisting to offset negative currency impact over time. Given China demand growth reduction, expect depressed prices to continue. Cotton On majority shareholder watching this closely (!).

Sales growth, particularly on line channels, not to be discounted. 5% comparable growth for what many had considered to be old brands and formats, for several half years in a row now, needs to be applauded. City Chic international sales growth exciting in this regard and Macy's wholesale sales relationship an interesting watchlist item.

Rivers moving to profitability in around 90 days (will be actually making money by the time you return from your extended European break). Remaining warehouse identified for closure executed this month. Considerable change given loss contribution of a staggering EBITDA $21.6m in 2015.

In my view, see fair value at between $1.10 and $1.30 a share, assuming a six times EBITDA, being in the region of $36m to $45m for 2017 (higher end assumes some positive Rivers EBITDA contribution of circa $5m, and another 1% of sales growth above lower end estimate of around 3%) and allowing net debt at 30 June 2016 of approximately $14m, which the company may beat should they be able to keep extended supplier terms as indicated in half year release. At current 60 cents a share, enterprise value of around $125m not demanding for a business expected to generate over $850,000,000 is sales in 2017, with a store footprint of over 1,000, rapidly expanding internet sales that is virtually free of net debt.

Sure, normal business risks remain, however on balance, given management's proven capability in counteracting 15% currency effect thus far, along with continued base sales/internet/international growth momentum, Rivers turnaround, cotton price offsets, CODB reduction plus generally positive-benign consumer outlook, happy to now back this enterprise.