Why the Pacific Brands Limited share price surged 10% today

A little dividend magic is bolstering Pacific Brands Limited’s (ASX:PBG) share price today even as it reported another big full year loss. But there are a number of encouraging signs that could send the stock higher still.

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A little dividend magic goes a long way. You don’t even need to pay one. Just a promise is enough as underwear and linen distributor Pacific Brands Limited (ASX: PBG) found out today.

The stock surged 10.4% to 42.5 cents in late morning trade even as management posted a net loss of $97.7 million for the year ended June 30, 2015.

However, the loss was a lot smaller than the previous year’s $224.5 million and the group’s second half performance actually rebounded strongly after Pacific Brands emerged from a painful restructure with adjusted net profit for the six months to end June growing 65.9% over the same time last year to $20.7 million.

Management is confident that the growth momentum will be sustained and said it will pay its first dividend since March 2014 at its half-year result next year. It is targeting a payout ratio of more than 50%, which could imply a 3 cent a share distribution for 2015-16.

That works out to be a pretty nice 7% yield before franking with the stock trading on a consensus price-earnings multiple of 10x for the current financial year.

I can see more upside to the stock and the 13% sales increase for its Bonds underwear business and 15% uplift in sales for its Sheridan bedding products business is encouraging. These two brands account for nearly 70% of group sales.

The group is aiming to open 18 new Bond stores this year as same store sales (which compares sales from stores opened for more than a year) is up 20%.

Pacific Brands’ balance sheet also hasn’t looked this good in a long while after management repaid all debt and reported a cash conversion of 119% (meaning it collected more cash than it reported in profit) due to lower inventory levels, which frees up capital.

However, it’s not all good news. Gross margins shrunk 0.8 percentage points to 49.3% due to discounting of its underwear wholesale business, higher product costs and the weaker Australian dollar as most of its products are sourced overseas.

Management is looking to mitigate the impact of the exchange rate through better sourcing of products, product mix improvements, cost cutting and price increases.

While group sales for the first eight weeks of this financial year are up 8%, much of its fortunes will depend on the crucial shopping season ahead of Christmas although management believes it can deliver earnings before interest and tax (EBIT) for 2015-16 that is ahead of last year’s $64.2million.

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Motley Fool contributor Brendon Lau has no position in any stocks mentioned. Follow me on Twitter - https://twitter.com/brenlau 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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