City Chic (CCX) December AGM trading update

City Chic’s costly inventory clear out - reveals margin pain

Published: 20 December 2022

City Chic has provided another trading update showing slowing sales in Australia. We think it is best to describe the company’s sales position as normalising. We doubt there is a rebound in FY24e. With a reversion in sales, the company’s inventory position is far too high and hence profitability will be largely wiped out in FY23e. The real question is to what level do profit margins recover? We forecast long-term EBITDA margins of 10% and a return to net cash by the end of FY23e. While it is a difficult 12 months and there are many risks, we reiterate our Buy rating with a target price of $0.85 per share (prev $1.25).

Sales trends deteriorate

City Chic’s sales trends have slowed in the past four weeks. At its AGM for the first 20 weeks, sales were down 2% FYTD, now for the first 24 weeks, sales are down 7%. Some of the weakness can be explained by the normalisation of sales in Australia given the reopening last year boosted November 2021. Sales are likely to be down 7% for 1H23e and we estimate a drop of 10% in 2H23e given less of a currency tailwind. Our FY23e sales estimate is $337 million, which, on our forecasts, means that Avenue dropped back towards its acquisition level and there is only modest growth in EMEA. Such a reset reframes its growth. While sales growth should resume, it will be costly to continue to acquire customers. We expect sales growth of 5%-12% going forward.

Gross margins down given excess inventory

City Chic has flagged an EBITDA loss for 1H23e. We forecast -$1.1 million with +$7.7 million in 2H23e. Our 2H rebound reflects a likely reduction in marketing costs and smaller headwind from fulfillment costs vs the pcp. We highlight two things about near-term earnings. Firstly, management has an incentive to make a small positive EBITDA across FY23e. A cash realisation above 1.5x will trigger short-term incentives. Secondly, management has an incentive to drop inventory. An inventory level of $125 million leads to full payment of this short-term incentive.

Can it get to net cash and where do margins settle?

With the share price as low as it is, the market is clearly sceptical about its ability to lower inventory and return to a net cash position. Given financial incentives for management, we expect inventory reduction is a major motivation. We forecast a net cash position of $10 million in 1H23e, rising to $42 million by FY23e. The company has historically targeted 15% EBITDA margins. We assume 10% on the basis that the company will have higher marketing, advertising and fulfillment costs in order to grow sales.

Earnings revisions

We lower our sales forecasts by 3%-5% over the next three years. We reduce our EBITDA (pre AASB-16) for City Chic to $7 million for FY23e from $19 million previously. A small loss across the full-year is possible. The swing factors for us are the level of discounting in 2H23e and the willingness to lower marketing costs.

Our view

City Chic’s sales performance suggests to us that the boom in sales over the past two years is in a large part a function of lockdowns. As a result, the company has far too much inventory and a financially painful 12 months to clear the product. However, fundamentally the company has a good market position in the plus-size market and its balance sheet should have a net cash position. We reiterate our Buy rating with a 12-month target price of $0.85 per share.

 

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