98% Drop in Net Income for Esprit.

by Michael Wei, Frank Longid. Editor: Frank Longid - Bloomberg Business Week

Sept. 15 (Bloomberg) -- Esprit Holdings Ltd., the biggest Hong Kong-listed clothing retailer, dropped the most in almost three years as profit plunged 98 percent on costs for closing stores and selling its U.S. and Canada operations.

“The brand has gradually lost its soul over the past few years,” Esprit said in a filing. “The heritage of the brand has been neglected and the company lost its customer focus.”

Esprit said it will focus its brand-building efforts in Germany, France, Belgium, the Netherlands and China after posting its third consecutive decline in annual profit. The casual clothing maker gets 79 percent of sales from Europe, which is mired in a debt crisis that is weakening consumer sentiment and economic growth.

“If the brand is to recover, management needs to invest significantly in the business, which means the earnings are not going to grow for a long period of time, say at least two years,” said Aaron Fischer, an analyst with CLSA Asia Pacific Markets in Hong Kong. He rates the stock “underperform.”

Profit excluding exceptional items fell 30 percent to HK$2.35 billion, Esprit said in its earnings statement to Hong Kong's stock exchange.

Capital Expenditure

Esprit had its biggest intraday decline in Hong Kong trading since Oct. 27, 2008, and was the worst performer on the benchmark Hang Seng Index, which gained 0.7 percent. The stock has lost 59 percent this year.

The retailer that started in 1968 in California plans about HK$7 billion of capital expenditure over the next four years, Chief Executive Officer Ronald Van der Vis said in a briefing in Hong Kong today. Additional operational costs over the same period will amount to HK$11.5 billion, of which HK$6.8 billion will be spent on branding, he said.

Esprit said it's targeting 8 percent to 10 percent cumulative average sales growth, in local currency terms, for the next four years. The retailer had 178 stores in Germany, 43 in France and 161 in Australia as of June 30. It had 1,141 retail outlets in total and operates 11,704 points of sale under its wholesale business.

Revenue for the 12 months through June was little changed at HK$33.8 billion. Esprit forecast sales to drop 3 percent to 5 percent in local currency terms in the fiscal year ending June 2012.

Store Closures

It set aside about HK$1.7 billion for store closures, almost four times the previous year's, and HK$944 million for the sale of its operations in North America. The retailer said it has identified 80 outlets to be closed in Europe and the Asia-Pacific region. Among the shops to be closed are 24 in Germany, 13 in Australia and 12 in France, according to a company presentation.

Closing the stores and the sale of the North American operations narrowed operating profit margin by 7.2 percentage points to 2 percent, Esprit said. The company expects to make a decision on the North American sale within eight weeks, said Van der Vis, who added that the “preferred option” was to find a partner to take over the unit.

Rising Costs

Occupancy costs rose 12 percent to HK$4.4 billion and staff expenses rose 8.7 percent to HK$4.9 billion.

Operating profit fell to HK$692 million from HK$3.8 billion a year earlier and the company doesn't plan to pay a final dividend.

Europe accounted for 79.1 percent of Esprit's sales in the year, while the Asia-Pacific region comprised 17.2 percent, according to the statement. Europe sales accounted for 83 percent in the previous 12-month period.

“European consumption is likely to be under pressure in the coming months, but Esprit's sales trends will depend above all on the new management's ability to improve the appeal of the brand,” Anne Critchlow, an analyst at Societe Generale in London, said before the earnings announcement.

“Esprit's problems include the wholesale division losing selling space due to customer closures and insolvencies in Germany and the economic downturn in Europe,” said Critchlow, who rates the stock “buy”.

The retail business increased 7 percent to HK$19.1 billion to account for 56.4 percent of its total sales, up from 53 percent a year earlier, Esprit said. The wholesale division, which includes franchises and “shops in stores,” had sales of HK$14.5 billion, accounting for 42.9 percent.