Description

Thesis 

At 227 pence/share,  the stock of Supedry PLC (SDRY LN)  offers an attractive  assymetric, investment opportunity. Notwithstanding the headwinds from the Covid related lockdowns, there are  tangible signs that the turnaround plan initiated April 2019 is gaining traction. If the new management team achieves  its goals of returning the business to prior levels of profitability and resuming growth,  the stock could be worth 3-5x its current price  (10-15x PE) in a couple of years. Although the company has been severely impacted by the Covid crisis, the risk of bankruptcy is  low. The company has a net cash position and  undrawn credit facilities.  Despite revenue declines and accounting losses, the company has continued to generate free cash flow during the turnaround process.   

Business Description

Superdry PLC is a UK based apparel retailer. It’s products combine vintage Americana with Japanese style. The products  skew heavily towards the Fall and Winter season. The company sees itself as providing the same quality as Woolrich or Canada Goose at half or a third of the price.

As per the annual report: 

“Our clear brand positioning is centred on creating amazing clothes, through an obsession with design, quality and fit, and is underpinned by relentless innovation and commitment to operational excellence in everything we do.” 

“Our customers are loyal and global and are defined by attitude, not age. Core to our brand DNA is the combination of market leading quality and design detail delivered at astonishing value for money. Sueprdry has democratic appeal, offering affordable premium clothing, accessories and footwear, complemented by newer lifestyle categories such as Sport and Snow.” 

In the fiscal year 2020 (FYE: April), the Company generated GBP 704 million in revenues through  241 owned stores (104 in the UK, 108 in Europe, and 29 in the USA) and 499 wholesale relationships (12 in the UK, 298 in Europe, 192 ROW). The tables below provide revenue and gross margin by channel.  

Source: Superdry 2020 Annual Report 

Company History

The rise and fall of Superdry is a familiar story in the world of small cap apparel retailers. 

In 1985 entrepreneur Julian Dunkerton opened his first fashion store, Cult Clothing Co, a curated multibrand store in the town of Cheltenham, UK, and expanded predominantly in University towns throughout the UK.  In 2003, Junkerton joined forces with designer James Holder and created the Superdry brand, which underpinned  the successful expansion of the  business.   In 2010 Superdry IPO’d for 500p/share and generated revenues of GBP 139 million  In 2014 Julian Dunkerton stepped down as CEO and was replaced by  Euan Sutherland. The move coincided with Dunkerton’s divorce and subsequent second marriage. The company continued in its growth trajectory under Euan Sutherland.  Revenues peaked  in 2018 at  GBP 872 million  and the stock peaked the same year at 2,076p/share.

In  2019 revenues were flat, but the company suffered a 400bps decline in operating margins and reported its first annual loss as a public company driven by a GBP 130 million store asset impairment charge.  Management’s missteps over the preceding years became apparent.  The Company had overexpanded in store locations  and wholesale relationships. The visual merchandising of stores had dramatically deteriorated. The ill conceived decision to go  from two main collections a year to four collections a year resulted in inventory issues, discounting, and gross margin erosion. Overall, Superdry, which had always been  a fashion driven company, had lost its “design first” focus.  The stock suffered an 80% decline from the high and stabilized around 400p/share before the Covid induced second leg down took it to current levels. 

The Turnaround Plan 

At the April 2, 2019 shareholders meeting, founder and ex CEO  Julian Dunkerton, who owns 20% of the shares, pushed for a complete reshuffling of the board and the management team. The CEO, CFO, and the entire board resigned. Peter Williams,  an experienced executive, was appointed Chairman of the board. Julian Dunkerton was appointed  interim CEO and subsequently CEO. Five new independent directors were recruited. 

In July 2019, Julian Dunkerton presented a turnaround based on the following pillars: 

• “Bringing back design excellence, and creating clearer customer segmentation.” 

• “Re-setting store profitability. Support for wholesale. Growth plan for ecommerce.”

• “Re-igniting the brand DNA through increased consumer engagement and social media.” 

Some of the key hires included: 

• Phil Dickinson appointed Creatitve Director on June 2019. He brings over 20 years in senior design roles at Nike. 

• Gordon Knox appointed Logistics Director August 2019. He brings 30 years of experience at Burberry and Argos. 

• Shaun Packe appointed Director of Global Sourcing August 2019. 

• Justin Lodge appointed Chief Marketing Officer, formerly at Boohoo. 

Some of the steps taken included: 

• Reorganization of the design team under Phil Dickinson under four basic style categories.  

• Resegmentation of customer into nine archetypes. 

• Store and merchandising revamp.

• Shift from four  back to two seasons. 

• Revamp of website and  ecommerce strategy. 

• Marketing shift to social media and editorial content. 

• Major restructuring and renegotiation of leases from fixed to percent of revenue. 

• Rent reductions of up to 50% on half of the leases and closing of unprofitable stores. 

• GBP 252 million of non-cash charges related to write down of “right of use assets.” 

• Pruning of wholesale relationships (Norway, Russia). 

• Write offs of uncollectible accounts.

• Exit of China joint venture. 

• Massive downsizing of the US expansion project. Closing of three distribution centers.  

• Inventory clearance. 

• Working capital reduction. 

• Reduced discounting. Return to full price mix at retail stores.  

• Shift to near sourcing (Turkey) to improve inventory management. 

• 20% reduction in payroll expense 

Impact of Covid

In the fiscal year April 2020 Superdry suffered a 19% decline in revenues. The decline was running 12.7% pre-Covid, but accelerated to down 71% yoy with the mandatory shutdown of European stores.

Fiscal year 2021 will bear the full impact of the Covid. Based on management’s guidance in November, one should expect a further 20% decline to GBP 560 million. 

Positive Cash Flows Versus Net Losses 

Despite net losses of GBP 89 million in FY 2019 and GBP 167 million in FY 2020, the  company has remained free cash flow positive both years. . In 2019 operating margin declined 400bps, but the company managed to generate a profit before non cash exceptional charges of GBP 127 million. In FY 2020, the Company swung to a negative 4.9% operating margin, and  net income was further impacted by  GBP 125 million of non cash exceptional charges. Cash flows in 2020 were driven by working capital rationalization and liquidation of inventory. 

Liquidity

Superdry has  enough liquidity to navigate the impact of Covid. At FYE April 2020, the company had a net cash position GBP 36.7 million (GBP 307.4 million in cash minus GBP 270.7 million in borrowings) compared to a net cash position at FYE April 2019 of GBP 35.9 million (GBP 49.5 million minus GBP 13.6 million of borrowings). Superdry’s cash needs peak at the calendar year end due to inventory build up ahead of the holiday season. As of the November 3 2020 “Pre Closing Statement,” the company had a net cash position of GBP 22.2 million versus a negative net cash position of  GBP 16.4 million in 2019. The company had not drawn on its recently renegotiated GBP 70 million ABL facility and its  GBP 20 million overdraft facility. 

Conclusion and Price Target
This company is not a quality compounder. It does not sell an essential product that people need to buy. It does not have the pricing power and gross margins of a luxury branded products company. It  is a fragile apparel retailer that has to deliver every year on many fronts (design, quality, logistics) in order to survive. Nonetheless, the stock, in my opinion, offers an attractive risk reward opportunity for the following reasons. 

• Anecdotally, the turnaround plan seems to be gaining traction. The design team is producing significantly better products. 

• The online business has finally accelerated. Ecommerce sales were up 50% year over year in 1H21 as per the November 3 Pre Closing Statement. This seems to confirm that the product is being well received.  

• The CEO has  a successful track record in this business and  a lot of experience. 

• The CEO is highly motivated and aligned with shareholders. He is the single largest shareholder.  He owns 16.6 million shares of stock and  bought 1.6 million shares in 2020. 

• COVID has severely impacted revenues, but it has also enabled the company to negotiate all its leases at much lower prices and to take advantage of government programs to right size its employee base. It has reduced payroll by 20% permanently.  

• Despite all its issues, the company has managed to retain gross margins in the mid 50% level.  

• Historically this company has generated a 9% net margin. Management’s goal is to start growing again eventually and to return to prior profitability levels. A 9% net margin is not heroic for a fashion business such as this one  when it is well managed. If we assume a return to 2017 revenues (GBP 752 million) and apply an 8% net margin it yields a net profit of GBP of 60 million and an EPS of 73 pence/share. Based on this calculation, the company is trading at 3x earnings two years out. At a 10x multiple, the stock is worth 3x its current level. If the company starts growing again, and the ,market assigns a higher multiple to the business (see DECK or CROX), the upside is significantly higher. 

• The downside is 1x, but probably less in the next year or two. The company has sufficient liquidity to survive a few seasons. The risk of bankruptcy, at least in the near term, is low. 

• Operating trends are more likely to improve than deteriorate. 

Risks

• The turnaround takes longer. Investors lose interest and the stock sells off 30 to 50%. 

• The turnaround gets derailed by any number of risks, such as the departure of the head designer or the CEO. I don’t have any reason to believe this will happen.  

• Covid lasts another twelve months. 

Catalyst

Concrete signs of a successful turnaround, not likely until the second half of 2021. 

Earnings revisions and price target revisions