Global Fashion Group - Value among the skirts.
Dear All,
Please find our initiation and financial model on Global Fashion Group (GFG) here.
GFG is suffering from macro issues (elevated inflation, cost of living crisis) which will take time to recover and structural issues e.g. competition & discounting in the ANZ division. As a result, NMV, customer and order values have continued to decline leading to negative operating leverage (the company is trying to control costs but still needs to make marketing expenses) and cash burn which is partially mitigated by a structural shift to a Marketplace focused model and more disciplined use of inventory. Management expects NMV growth to return in H2 2024 but until then it is a "show me" story with high execution risk.
Investment Rationale
- We are on the sidelines on the Convertible Bonds for the time being as we wait for NMV volumes to recover and the group to break even on a free cash flow basis.
- In a scenario where free cash flow generation does not occur a straight paydown of the bonds at par is unlikely as management wants to maintain its options for the business as an ongoing concern and this will require liquidity for working capital and payables. Therefore our base case is a partial paydown of the convertible with a parallel elevation of the notes which may or may not lead to par recovery.
- The position of the convertible bond at the Luxembourg Holdco further weakens the options of the holders to enforce and hence they may need to negotiate with management to reach a consensual solution.
- So far management appears to be more focused on keeping the combined business together and waiting for NMV growth to turn positive. In addition, there are also making opportunistic buybacks of the bonds at a
discount to par to crystallise the trading price discount. The above dynamics are beneficial to the shareholders of GFG but are not a catalyst for the bonds moving to par until GFG becomes cash flow break-even or the bond put date comes closer. Hence a "wait and see" approach is warranted at the moment.
Current Trading - waiting for growth to return
- Net Merchandise Value, Orders and Revenues have declined by 16.5% and 18% in Q1 2024 respectively due to elevated inflation and a decline in demand from the cost of living crisis in the geographies that it operates in. A gradual improvement in inflation will be the key catalyst for a resumption of growth which we are assuming will return only in 2025.
- Management is controlling the variables that are within its control e.g. Q1 2024 gross margins improved by 3% points to 44%. They are also transitioning the business from retail to marketplace, more efficient inventory management and scaling of platform services.
- High fixed costs: GFG needs to continue to invest in capex (Tech & PPE), lease costs and marketing expenses every year to attract a new cohort of customers and maintain its competitive edge in the marketplace which makes reaching positive free cash challenging.
- Pro forma for the latest convertible bond buyback, the cash balance of €304 million is high but as the company has no RCF, it needs the cash to finance the operations of the business, therefore the cash balance is expected to continue to decline going forward to €200 million by the convertible bond put date (according to Sarria estimates).
- The only way the cash balance would increase is a return to positive growth in NMV leading to operating leverage and free cash flow going forward.
Housekeeping
The next catalyst on this name will be the Q2 2024 financial results in August and any new convertible bond buybacks. The questions that investors would like clarity on is when do they expect NMV and order value growth to turn positive and the company to generate positive EBITDA.
Saahil
T: +44 203 192 0200
www.sarria.co.uk