PMMAF - Puma: Sitting This One Out For H1 2023

2023-03-04 06:05:56 ET

Summary

• PMMAF's FY22 earnings saw constant currency sales growth of 18.9%, with EMEA growing by 22.5%, the Americas by 28.3%, and Asia-Pacific shrinking by 2.2%.
• PMMAF is likely to face headwinds in FY23, including an unfavorable competitive landscape and excess inventory leading to high promotional intensity.
• Gross margin will be under pressure in the first half of FY23 due to persistent sourcing/freight cost inflation and promotions, but these headwinds should abate or even reverse.

Overview

Puma (PMMAF) story of expansion and profit margins is compelling thanks to the company's persistent efforts to strengthen its distribution and product offerings through effective advertising. PMMAF, in my opinion, will be able to overcome the difficulties it faces in FY23 and deliver increased EBIT, in line with market expectations, thereby supporting its long-term thesis of expanding market share and EBIT margins. That said, I believe PMMAF is likely to face a number of headwinds in the coming months, including an unfavorable competitive landscape, in which it is likely there will be high promotional intensity to market their excess inventory - which I expect to impact gross margins in 1H23. Management also struck a relatively cautious tone throughout the call, suggesting that the recovery would not be immediate, even though management is optimistic about the brand's long-term prospects in China. I am recommending to stay away from the stock until we get past 1H23 (so we can have a sense of margin cadence).

FY22 earnings

PMMAF's 18.9% y/y constant currency sales growth was a major contributor to their in-line €640.6 million EBIT for FY22. EMEA grew by 22.5%, the Americas by 28.3%, and Asia-Pacific shrank by 2.2% in constant currency terms for FY22. Apparel sales increased by 10.1% y/y, compared to 30.8% for footwear and 5.4% for accessories. Gross margin dropped by 180bps to 46.1% and its operating profit margin dropped by 60bps to 7.6%. The increase in inventory by 50.4% compared to the previous year was due to the early accumulation of stock to counter the effects of the supply chain disruption. Additionally, the rise in the cost of sourcing raw materials and freight rates resulted in higher prices. Though, this was an improvement from the 72.3% y/y increase seen at quarter's end. The proposed dividend of €0.82 would result in a payout ratio of 34.7% for FY22. There were some bright spots - The CEO has stated that a 10% EBIT margin is attainable by FY25 & The Rihanna partnership has returned and will now include products beyond womenswear; these products will debut in the second half of the year.

Margins under near-term pressure

PMMAF provided qualitative guidance indicating gross margin would be under pressure in FY23. Gross margin will likely be lower in 1H23 than 2H23, management said on the call. The combination of persistent sourcing/freight cost inflation and promotions will weigh on GM's performance in 1H23, but these headwinds should abate or even reverse in 2H23. However, in 2H23, FX will begin to actively work against GM. On this point, CFO said that hedging for 2HFY23 was done in 2HFY22 with dollar-euro parity. That said, management has promised to keep pouring resources into the brands (with marketing expenditure indicated to remain at 10% of sales going forward). This means that higher DTC countries like China and India will have an indirect impact on operating leverage. Importantly, management has stated that a 10% margin by FY25 is "realistic" if cost headwinds stabilize. While I am optimistic on PMMAF 10% margin target, I prefer to see actual results from this 1H23 and management commentary for 2H23 in the 1H23 call. As of today, there are still many uncertainties - which I don't feel comfortable putting my money on.

Conservative guidance

Prior to COVID, PMMAF typically took a conservative approach when establishing its guidelines. In most cases, share prices dropped immediately following the release of guidance but recovered once Q1 delivery began showing the true potential. The new CEO first appearance on the quarterly call seemed to follow a similar script, at least in my opinion. There have been few comments about the resilience in current trading performance so far in 2023, although PMMAF expects constant currency sales growth in the high single-digit percentage range in 2023, and EBIT are expected to fall within the range of EUR590 million to EUR670 million. However, I think the good news is that management did give some positive indications for China for January and February, but overall growth in China is only anticipated to be in line with or slightly ahead of expectations. PMMAF believes that market share gains are implicit in the guidance, which I take as a rather conservative view for the industry, especially if China's normalization process accelerates - it could lead to earnings surprises.

Conclusion

Despite the cautious comments (e.g. the quality of US distribution needs to be improved, the China recovery may be limited, the gross margin recovery will be H2 weighted, OPEX leverage is not guaranteed) overshadowing the positives, notably a 10% EBIT margin should be achievable by FY25. Although I believe that PMMAF's recovery in China could be stronger than company comments suggest (particularly in H2), I will sit this one out due to the uncertain near-term catalysts.

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