Retailing is a tough enterprise at the best of times. The business graveyard is littered with retailers who couldn’t tough it out, and your local Westfield Group (ASX: WDC) has more than a few stores who are either already on life support or only a few bad months from the intensive care ward.

At the pointiest end of this difficult sector is apparel retailing. Rag traders have to deal with changing consumer trends, the increase in spending online and the vagaries of the weather which can dent even the best laid plans.

Billabong International (ASX: BBG) has jumped headlong into a market where angels fear to tread. So far, the results are mixed and the market has passed swift and public judgement – the shares fell almost 70% from as high as $9.00 in February this year to as low as $2.81 only 7 months later.

The price has recovered somewhat in the past few weeks, but the combined wisdom of the market suggests this is a business still worth less than half of what it was earlier this year.

If investors have over-sold Billabong, today’s price might be a bargain. It could also be a falling knife – and trying to catch those can only end badly.

Targeting the global teen

Billabong has expanded a long way since its humble beginnings. Started on the Gold Coast in 1973 by a surfer who wanted better board shorts, the company expanded overseas throughout the 1980s and in the next decade, expanded to other ‘board’ sports including skateboarding and snowboarding accessories and apparel.

Billabong International has also grown geographically, being well established in North America, Europe and Asia, and with plans to expand into South America.

A beach-house of brands

The company is much more than its namesake surfwear brand. While the iconic name still makes up around half of Billabong’s sales, other brands in its stable include Element, Von Zipper, Sector 9 and DaKine.

If you haven’t heard of some of those brands, I’m sorry to tell you that the company would probably be quite pleased. In one of the most fickle of fashion categories – teen board sports enthusiasts – being edgy and cool is very important, and becoming too mainstream can be a brand killer.

Growing pains

You only need to switch on the television to see Woolworths (ASX: WOW) Big W and Wesfarmers (ASX: WES) Kmart making a huge point of telling you how cheaply you can buy kids and teens clothing. These products are often being sourced directly from the manufacturer, with the retailers looking to boost their margins, lower their prices, or both.

The same phenomenon was taking place in the surfwear retail space, and Billabong was finding itself stuck in the middle – and unhappy with that position.

Poacher to game-keeper?

The company chose put itself in charge of its destiny by moving deeper into the retail space. It acquired retailers in the USA, Canada and Australia, lifting its ‘direct to consumer’ sales from 24% of the company’s total sales to 38% in the last financial year.

This fundamental shift has come at a cost. Billabong has taken on a significant debt load, and the retailer acquisitions have resulted in lower profit margins so far. At the same time the stronger Australian dollar has had a negative impact on reported profits, and the retail environment remains weak. Depreciation has increased, the interest bill has soared and return on capital employed has fallen.

What has turned into something of a perfect storm for the company is at least partly of its own making, and shareholders appear to have little faith in Billabong’s strategy.

Billabong now trades on a forward price earnings ratio of less than 10 on my estimates, and a dividend yield of over 6%. Of course, further deterioration in the business can’t be ruled out – and that’s where the risk and opportunity meet.

Foolish take-away

Billabong is at a pretty important inflection point. Large licks of debt, a significant shift in company strategy and plans for increased global growth all ratchet the risk levels up to somewhat uncomfortable levels.

If Billabong can pull off its plan, it will exit this troubled time with greater control of its brands, improved margins, higher sales and a steadily reducing debt burden. If the gamble doesn’t pay off, investors are in for a period of stagnating returns – or worse.

This particular wave is a high risk, high return ride. Surfed well, it’s a 10, but the risk of wipe-out is ever present. If you know the break well, it might be a wave worth catching. If not, maybe it’s safer waiting for the next set.

Are you looking for more quality stock ideas? Motley Fool readers can click here to request a new free report titled The Motley Fool’s Top Stock For 2011-12.

Scott Phillips is The Motley Fool’s feature columnist. Scott owns securities in Westfield Group, Westfield Retail Trust and Woolworths. The Motley Fool’s disclosure policy never wavers. This article authorised by Bruce Jackson.

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