City Chic’s exit of Avenue and capital raising conclude an incredibly painful experience of global ambition and then retreat. The City Chic brand has a strong following in Australia but has been impacted by excess inventory. The company is addressing its cost base but more savings will be needed to restore profitability. Moreover, store openings seem unlikely at this stage given the poor sales productivity.

City Chic’s 1H24 EBITDA was at the top end of the guidance range given in late January 2024.  While losses are starting to reduce and gross margins improve, the sales base is much smaller. We expect sales to stabilise around May 2024 and anticipate noticeable gross margin improvements. City Chic also outlined a range of cost saving measures to restore profitability that will show through in 2H24e.

City Chic had an incredibly challenging FY23. Sales declined and gross margins were crushed. The company made an EBITDA loss (pre AASB-16) of -$35 million for the continuing business.  However, there is light at the end of the tunnel. The sales decline should abate by the end of 1H24e. The company has a net cash position and a clear path to profit margin recovery over the next three years.

City Chic has announced the sale (exit) of its UK and European business for A$12 million. This a modest price given it paid close to $50 million, but it does simplify the group and further improves its net cash position. We lift our EBITDA (pre AASB-16) in FY24e from -$6 million to -$1 million. Medium term, we have lowered our EBITDA by close to $3 million, indicating a 4x multiple for the exit. The strategic review clearly signals a focus on simplicity for City Chic and there is sufficient upside in the Americas and Australia/NZ for the group. Its net cash position also adds to the appeal and is a key feature of our positive rating.

City Chic’s sales run-rate stepped down materially in 2H23e with sales for the half likely to be $128-$132 million, down 29% on the pcp. Elevated discounting is the primary driver. The quality of inventory does also worry us. The company’s guidance that gross margins are down 18 percentage points, suggests that almost two-thirds of its sales drop is a function of lower realised prices. We expect weak sales to continue in 1H24e as discounting continues. Sales should recover in 2H24e onwards. However, the sales base is likely to settle around $316 million in FY25e, far below aspirations of $400 million only six months ago

There is much to debate about when retail sales slow, how far sales drop and how much margin downside will be associated with the sales weakness across the sector. We think the central driver of the debate is how quickly and far interest rates rise. In our base case (67% probability), the RBA reaches 2.5% cash rate by December 2022. In our downside case (33% probability), the cash rate reaches 4.5% by June 2023. There is downside risk to earnings for retailers over the next 18 months. We expect a volatile 12 months and advocate caution.

City Chic provided a trading update about sales and EBITDA for 2H22e. Sales growth is 25% so far in 2H22e, which is 4% below our estimate. The lower than forecast sales were more pronounced in the Americas business. We expect a small pick-up in sales growth for the remainder of the half with 28% growth forecast for 2H22e. The company expects 2H22e EBITDA to be slightly ahead of 1H22. We forecast 2H22e EBITDA of $23.7 million, compared with $23.5 million in 1H22.

City Chic has a strong sales growth outlook but profit margins are likely to remain near current levels. Premier has a modest sales growth outlook from here and profit margins may fall. However, we see optionality given the company’s balance sheet. Premier may accelerate Peter Alexander store rollout, acquire a controlling stake in Myer or acquire a fashion business in youth apparel or accessories.