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Trading Diary

Trading Diary – 30 October 2019

We’ve exited our position in Charter Hall (CHC) and reallocated these funds into Kathmandu Holdings (KMD). Following this transaction, we will have no further exposure to the Real Estate sector.

Sells

Charter Hall (CHC)

Sold for a 32% capital gain. We also collected more than 2% in dividends during our approximately eight-month holding period.

We’ve owned Charter Hall since February 2019. It was amongst the first group of stocks that we bought into when we reestablished our position in the stock market this year. The Real Estate sector made up a significant proportion of our portfolio at this time. It was one of the most robust performing areas of the market during the volatile 2018 and early 2019 periods.

Charter Hall has been the best performing stock in the sector over the last 12 months, and we have captured a large portion of this return. However, the stock now appears to be consolidating and entering into a new trading range. We can see this visually on the chart as well as in the shares declining momentum scores. As a result, we’ve sold our position and reallocated the proceeds into a situation with higher immediate return potential.

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Buy

Kathmandu Holdings (KMD)

Kathmandu designs and markets, clothing, footwear, and equipment for travel and adventure under the Kathmandu and Oboz brands. It has also recently acquired Rip Curl which designs and markets apparel and equipment for the surf market.   

Technicals

The stock briefly tagged its 52-week high last week before retreating a few percentage points over the next few days. It has risen rapidly off its 52-week low over the two months following the release of a trading update on August 8. 

The break to new highs has created a rounded cup formation on the weekly chart. The depth of the cup is ~30%, and we can see that volume and range dried up significantly towards the lows. The stock has been in the process of tracing out this formation for more than a year.

A pause at these levels is likely as some of those investors trapped in the issue from when it made its previous high look to make a quick exit. The stock certainly looks like it is under accumulation at this stage. It has increased volume and range expansion during positive weeks and muted volume during down weeks — all positive signs. 

I’ll be looking for a breakout to the upside following a period of consolidation to confirm that this was indeed an accumulation.

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Fundamental

Value

Kathmandu ranks around the middle of the pack for valuation. It has a price to earnings multiple of 14x, an EBIT/EV multiple of 11x and a price to sales ratio of 1.6.

When compared against its peers in the specialty retail industry, these multiples look reasonable and give KMD some room for multiple expansion.

CodePrice to EarningsEV/ EBITPrice to Sales
PMV27.8x16.4x2.4x
LOV44.6x27x5.8x
AX118x10.9x5.8x
BBN41.7x24.5x1.3x

Multiples, however, by themselves, mean nothing. They give us a rough insight into what the market expects the company to achieve going forward in terms of growth and profitability.

How fast the company is expected to grow revenue and for how long. Then how much of this revenue growth will be left for shareholders (i.e. profitability and free cash flow).

The market currently expects KMD to maintain its current level of profitability and achieve marginal top-line revenue growth. Not the lofty expectations ascribed to the likes of LOV, PMV and BBN but still not nothing.

Growth

KMD has consistently grown top-line revenue by mid-single-digit figures for the last few years. 

Excluding North America, sales increased +2.1%. Sales in North America grew by 28.2%, bringing total sales growth to 9.7% for the full-year. Same-store sales grew by 0.6% during FY19.

Kathmandu only gross margin was 63.6%, while North America gross margin came in at 40.8% during FY19. The deterioration in group gross margin from 63.4% to 60.9% during the year reflects the increased North America wholesale contribution.

Asset turnover was 0.9x for the year, up from 0.8x during the previous year. Return on assets was also up for the year to 13.7% from 12.1%.

Financial Strength

KMD ranks well for financial strength. Internally generated cash flow was able to fund growth over the last 12-months (not including acquisitions).

The company is taking on a heap of new debt ($220m) to fund the acquisition of Rip Curl, which will affect its financial strength ranking.

Debt makes companies fragile. When a company has a pile of debt on the balance sheet, a change in economic circumstances or consumer tastes can bring a company down. Cash, on the other hand, makes them antifragile, giving them options during an economic downturn to make new investments at reduced prices.

Narrative

We won’t know for some time how smart the acquisition of Rip Curl will turn out to be. However, for the time being, it is changing the narrative around KMD.

The company is no longer a purely domestic-focused specialty retailer with a single-digit growth opportunity. Rip Curl allows Kathmandu to accelerate its US entry.

Also, Kathmandu is predominantly direct to consumer retailer while Rip Curl relies heavily on the wholesale channel. KMDs expertise in direct to consumer, both in-store and online could potentially give Rip Curl the ability to accelerate growth in these channels.

The uncertainty around these two potentialities could ignite a new uptrend in KMD. Especially if early success in either area is forthcoming. 

The world is a big place. Any indication that the Kathmandu brand is resonating with international (particularly US) consumers will be very positive for the stock. 

By Danny Sandler

Founder of Ocean Asset Management.