Pacific Brands Limited: An investor’s view

Pacific Brands Limited (ASX:PBG) recently announced an upgrade in profit guidance, but at what price.

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Pacific Brands Limited (ASX: PBG) is engaged in the sourcing, manufacturing, marketing, wholesaling and retailing of underwear, socks, hosiery, intimate apparel, bed linen, bedding accessories and carpet underlay. Products are sold throughout the Asia Pacific region, United Kingdom, Europe, Middle East and United States.

The company recently announced that sales for the year are expected to rise 5.3 per cent, after growing 6 per cent in the first half, as strong growth in Bonds and Sheridan retail stores offset continued weakness in wholesale accounts, including discount department stores such as BIG W and Target.

Selling the farm

After selling $226 million of assets last year, including its Hard Yakka and King Gee workwear business to Wesfarmers for almost $190 million and the Volley, Grosby, Everlast, Slazenger and Dunlop clothing and footwear brands to Anchorage Capital Partners,  – the company now has a net cash balance, for the first time since listing in 2004.

That all sounds great, but!

While this type of strategy may sound ok in the short term, ‘selling the farm’ and reliance on ongoing strong sales in Bonds and Sheridan, will prove highly problematic.

The cornerstone of Pacific Brands’ turnaround strategy is to roll out a number of new Bonds and Sheridan bricks-and-mortar and online stores.

This is the last roll of the dice for Pacific Brands.

In what I see as the last roll of the dice for Pacific Brands, the company has a history of continually failing to provide reasonable returns on its capital. Its strategy, for as long as I can remember, has been to sell off brands so that it can manage fewer brands which will hopefully translate into significantly higher returns.

But what happens when you don’t have any more brands to sell off and you’re not achieving significantly higher returns?

The problem for Pacific Brands is that it competes in a mature and highly competitive market. Large retailers have made life very difficult by reducing their margins and floor space. To counteract this, Pacific Brands has been forced to create its own direct retail and online outlets. But, we all know the inherent risks associated with bricks-and-mortar businesses, particularly in highly competitive markets.

While I don’t disagree that there is money to be made in bricks and mortar businesses, nor do I disagree that Bonds and Sheridan are not powerful brands, I do argue that these two things together will not be enough to save Pacific Brands.

Other factors that impact Pacific Brands are manufacturing risks associated with China’s cost inflation, depreciation in the Australian dollar, currency headwinds, and the need for ongoing store roll outs, product improvement, and the associated advertising and marketing.

Valuation

It’s hard to believe that Pacific Brands’ share price was $3.70 back in July 2007. It now trades at just $0.43, and that’s up 34% from around $0.30 at the end of June. For me, now is the time to sell its shares.

Motley Fool contributor John Hopkins has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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