Pac Brands prepares to break with the past

NATIONAL: Listed retail and wholesale group Pacific Brands looks set to implement "aggressive" cost cutting measures to avoid a case of history repeating itself.

Analysis from Macquarie Research Equities, a division of Macquarie Group Australia, indicated the group suffered a 30 per cent decline in earnings before interest and taxes (EBIT) during the 1996/1997 economic downturn.

In a report titled 'Pacific Brands: Cheap on surface, but risk a hidden cost' released late last month, analysts disputed the group's assurances its 'everyday essentials' offerings were resilient during tough economic times. It estimated the company's EBIT declined by 11 per cent in 2001 - another challenging period for retailers - despite a portfolio which included underwear basics brands such as Bonds and Berlei, hosiery, workwear and footwear.

The essentials premise was again called into question late last year, when the company issued a profit downgrade at its annual meeting. Previous guidance for a flat profit in the first half of fiscal 2009 and a return to profit in the second half was replaced with a "target of flat profit at best" for the full year.

"Pacific Brands equity value was savaged in 2008," the report stated, noting its share price fell by a staggering 78 per cent from September 30 to December 30, 2008. "While its share price declined across the whole year, the real hit came in the fourth quarter."

Conditions were not set to ease in the year ahead, analysts claimed. Among the key operational challenges for the net importer was Australia's depreciating dollar - with 58 per cent of goods and related services carried out in US dollars.

"We expect currency driven [cost of goods] inflation of $184 million between fiscal 2008 and fiscal 2010 - partially offset by commodity, manufacturing and transport cost deflation," the report noted. "In fiscal 2010, Pacific Brands will no longer benefit from relatively favourable hedging and as such, will feel the full brunt of the AUD depreciation."

Trade feedback suggested Pacific Brands had already attempted to offset this pressure by implementing 15 per cent price increases across its portfolio. However, Macquarie Research Equities analysts believed the company would focus on slashing its sales and marketing budget to protect margins. The company invested $407 million in this area over fiscal 2008, representing its second largest expense line after the cost of goods.

"Management can seemingly alter their spend to adapt to trading conditions," the report noted, referencing fiscal 2006 when spending cut resulted in 0.3 per cent net profit growth. Had the group invested the same amount in above-the-line advertising as fiscal 2005, the net profit after tax would have declined by seven per cent.

Analysts said the group would also look to reduce variable expenses such as travel and entertainment. A recently launched strategic review into the company was expected to introduce further cost cutting initiatives.

"Sales are expected to decline and currency driven cost of goods inflation means significant other operational cost reductions are necessary," the report claimed.

Macquarie Research Equities expected EBIT at Pacific Brands would decline by 16 per cent or $37 million between fiscal 2008 and fiscal 2010.