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Pacific Brands – No More Hard Yakka

Flannos, Stubbies and thongs were acceptable casualwear back in the day. But fashions change and therefore so do brand values. That is the story of Pacific Brands which has seen its portfolio of iconic clothing and footwear brands diminish in value, dragging shareholder value down with it.

Pacific Brands announced its full year results for 2014 that included yet another huge writedown in the value of some of its brands and the sale of the workwear business to Wesfarmers.

PBG bought the Yakka Group in April 2007 for $240 million, which included $100 million of brand name and intangible value.

This week, it sold that business to Wesfarmers for $180 million after writing down the value by $241 million in its financial result.

Yakka Group includes some of those iconic Australian brands such as Stubbies, King Gee and Hard Yakka.

Over the approximately 7 years of PBG’s ownership, the workwear division (including Yakka and the uniform manufacturing business) produced average operating earnings of $38 million each year although it plunged to $22.1 million in FY14. Sales averaged around $380 million per annum and barely grew over that period.

Part of the problem has been the cyclical nature of demand for uniforms and industrial workwear but PBG has also struggled with the cost of manufacturing and distribution.

Waving goodbye to Yakka allows PBG to reduce debt a little, but in the same breath, the company is talking about focusing its efforts on the household brand names of Bonds and Sheridan. Good brands, yes. Good businesses? No.

PBG will continue to struggle with the enormous amount of working capital it is forced to carry by its main customers, the very powerful discount department stores and other major retailers. PBG’s working capital to sales ratio is always above 20% and creates large fluctuations in operating cash flow when seasonal stock doesn’t sell through, or fashion trends change leaving PBG holding the obsolete stock, not the retailer. Kmart brutally demonstrated this aspect back in 2008 when it restructured its own business and gave PBG a bloody nose in the process.

At a group level, PBG has a poor track record of adding value to its brand portfolio. In fact, it has successfully destroyed great wads of shareholder value as the following chart of group intangibles shows. The chart includes the various writedowns declared which were mostly declines in the value of brand names.

The value of intangibles on PBG’s balance sheet has now shrunk to $350 million from $1.5 billion when Yakka was first purchased. Not all the decline is due to Yakka but it has suffered the same fate.

Successive chief executives have grappled with the high cost of manufacturing in Australia that crippled PBG’s operating performance. Sue Morphett endured heavy criticism when she finally confronted the issue by shutting large amounts of Australian production capacity and replacing it with Asian-sourced goods.

The 1,000-or-so employees within the workwear business will now become the concern of the Wesfarmers Industrial and Safety division. The distribution of the products seems likely to benefit from the fact that Wesfarmers owns Kmart, Target and Coles supermarkets which should negate some of the underlying problems of the business.

As for what’s left of PBG, new chief executive David Bortolussi will try to wring some better earnings out of it, but he’s up against a difficult trading environment and the task of selling more stuff more profitably regardless of the tag.

This stock is an easy one to simply avoid in a portfolio. Its dismal track record speaks for itself and the share price has shrunk from more than $3 pre-GFC to around its current mark of $0.52.

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