Updated: May 25
Note to readers: This article was written on Sunday 23rd of May, when Ted Baker's full year results were to be announced on Thursday 27th of May. Ted Baker has since delayed results to the 10th of June due to disruptions to their audit processes due to Covid-19. Ted Baker has also updated investors with notice of an extension to their revolving credit facility. Investors should be aware that this article does not serve as a recommendation to buy or sell Ted Baker PLC and carefully consider the recent updates from the company before making any decisions.
Ted Baker reports results on Thursday 10th June (date amended on 24th May due to Ted Baker postponing results). Here’s a review of the current situation including an analysis of the company's turnaround strategy and what to look out for when Ted Baker reports next week.
Ted Baker, the British fashion brand behind smart-casual short sleeve shirts and bright pink women's purses, has had a tumultuous few years. Shareholders have been caught off guard by a number of unfortunate events. Things were already going wrong for Ted by the time the founder and then CEO Ray Kelvin was ousted amid a forced hugging scandal in 2019, however, falling sales, inventory write-downs, an over-reliance on the wholesale channel and the compounding effect of Covid-19 has left Ted Baker in a precarious position. The shares have lost around 90% from their 2018 levels, and the company was forced to raise equity and even sell their office in London in 2020 for £78 million to maintain financial stability. Ted Baker plc has been duly punished for its poor performance, however, it could be an ideal opportunity for investors to bet on a turnaround with the shares at rock bottom levels. This article will aim to shed some light on the recent stumbles and highlight the strategy for Ted’s turnaround ahead of the results next week.
How did we get here?
Ted Baker used to be a darling of the British stock market, with the shares rising sharply after the financial crisis in 2008 to a valuation of over £2 billion by 2016. Ted Baker was making progress with both an effective brand-building campaign, positioning itself as a notable brand within the affordable luxury category and an ambitious store roll-out, opening stores and concessions across the UK, Europe and the US. In the last communication to investors, the total store estate, including joint venture locations, stood at 534 units. In the years up to 2019, revenue growth had been strong, with double-digit growth in the years 2016 to 2018. However, this hot run came to a halt and growth started to slow in 2019. Profit margins were also crimped as Ted was forced to turn to discounting its products to compete with the rest of the high street.
Whilst the forced hugging scandal, which led to the ousting of founder CEO Ray Kelvin, likely didn’t help matters, Ted Baker was in trouble before this came to light. For me, the two main factors that have led to Ted’s downfall are its poor financial performance (falling revenues and profit erosion) and a breakdown in corporate governance, which over time has led to a serious decline in the share price.
Ted Baker results to January 2020 - Investor Presentation
To focus on financial performance first, the underlying profit before tax chart above helps explain some of the pressures Ted Baker faced during 2019. The main impact to underlying profit before tax has been gross margin decline, led by margin decline in Ted Baker’s retail channel. Higher levels of promotional activity (sale items) and a weak womenswear collection meant Ted has had to heavily discount its products to shift its stock. Distribution and administrative costs were also up significantly, which also puts pressure on margins. At the most recent results for the half-year to August 2020, we were able to see the further impact of the pandemic in Ted’s financials, with further erosion of gross margin by 5.5% showing the already deteriorating margin has been further exacerbated by the pandemic. This deterioration is, unfortunately, the result of being on the wrong side of trends, typically as Ted Baker is more weighted towards the smart-casual/office formal wear, which hasn’t seen the growth that athleisure or comfortable home-wear have been privy to over the last few years. The pandemic also accelerated the adoption and purchasing of loungewear and certainly decreased the need for formal wear. It is also the risk that companies in the ‘affordable luxury’ segment face. Brands in this segment do not have the pricing power that high-end luxury brands such as Louis Vuitton or Chanel have, nor are they appealing to a customer with enough money to not feel the pinch in tough economic times. They also do not benefit from the trade down effect that brands like Primark and H&M likely get when tough times call for more affordable clothing. Thus, any trend missteps or economic pressures are likely to cause an impact on Ted Baker’s gross margin and bottom line equally. Looking to governance, Ted Baker has had some significant missteps here in recent times. I have previously written on how poor management teams often cause a number of issues over time in my quality stock-picking guide, and I am afraid to say a similar thing has happened in the case of Ted Baker. Quite often episodes of poor governance that lead to a headline issue for a business is a sign that there could be more to come. In the instance of Ted Baker, the scandal surrounding Ray Kelvin wasn’t necessarily correlated to other issues, but it could have been a good signal that ethics and governance weren't exactly a strong point for the company. In January 2020, Ted Baker announced that it had overstated its inventory by £58 million. The removal of the inaccurate inventory meant that the restated value was £205 million in 2019. Whilst Ted acknowledged this overstatement was with regards to a historic measure carried forward from prior years, it is pretty terrible financial management to overstate your inventory by nearly 30%. Ted has gone some way to rectify these missteps by contracting Deloitte to audit the finance department, employing a new chief financial officer and reorganising the finance department. However, this doesn’t rule out issues further down the line.
What is the strategy going forward?
As you can see from the above graphic from the latest investor presentation, Ted is focused on three specific pillars to turn around the business. Firstly, Ted Baker are prioritising their products, with a much-needed refresh and a re-positioning towards more on-trend casual apparel lines. They have also hired a new creative director, an ex creative director from Topshop and Roberto Cavalli, to help them achieve this. The second pillar is to prioritise digital channels and capital-light growth by investing more in the Ted Baker online channel and also exploring license and joint venture opportunities to extract value from the brand without deploying too heavy an investment. The last pillar is the cost out programme, which is all about managing costs, optimising the store estate and improving efficiencies, to which Ted expects to improve cash flow and profitability.
For me, this turnaround strategy hits all the important factors that were issues for Ted’s performance in the past. The brand and product offering was a key issue, and Ted will need to work hard to reinvent itself in new categories. In Ted’s favour, pressures have been felt from a decline in their core category, as opposed to a failure to resonate with customers on a brand level or failure to provide quality products, thus, you could assume a switch into other apparel lines is possible. Strength in digital is also key moving forward. However, I think the most difficult part of Ted’s turnaround strategy will be managing the balance between eCommerce and the physical store estate going forwards. A physical store presence does aid brand recognition, and their core customer base is 30-50 year old’s who likely have a higher preference for physical retail than online channels. However, if Ted fails to fully optimise the physical store estate, price points will be much higher than its online-only competitors and gross margins will continue to be under pressure.
How likely is this strategy to work?
Firstly, looking at Ted's strategy behind revamping the product line, the graphic above from their latest investor presentation depicts how Ted aims to bring more customer-centric products to market for its upcoming seasons. By focusing on a core line of products with a history of selling well, whilst also allowing space to integrate lines with unfamiliar trends, Ted Baker aims to use a test and repeat model to optimise the product portfolio. Seeing as this model has been launched since the enrolment of the new creative director, it is likely that it echoes similar successful product models that have been used in the success of Topshop’s trend-following apparel lines. Ted is also going to pursue a monthly drop, a model that has shown success in other brands, to increase loyalty and repeat buying. Whilst these strategies and initiatives are a welcome focus back on the product offering and certainly are an improvement from prior years, there is no certainty that Ted will manage to pull off its ambitions as a trendier entity.
Looking at Ted's second growth pillar of prioritising digital, I think this is an area where Ted can make some real inroads. With an already established brand, investment in the digital channel for the business could aid the turnaround significantly, boosting reach through a lower cost and more flexible channel. With the prior prioritisation on physical retail and the wholesale channel, deriving only 19% of sales online for the year in 2019, Ted has underinvested in its online segment over the years. A new eCommerce platform has been integrated and the addition of new easy pay methods will further improve conversions with online customers.
In the latest interim results, the eCommerce channel saw growth of 42% as the pandemic caused lockdowns across the physical store estate and a boom in online shopping. This strong growth in eCommerce meant that 44% of revenues were derived from the online channel in the first half of 2020, up from 19% for the full year prior. This goes to show how important a multichannel strategy is and that the investments made into the digital channel have been worth doing.
However, to some extent, Ted Baker also faces challenges online, with a vast array of competitors, ranging from online-only fashion businesses, other multichannel operators and smaller upstarts taking market share across social media. Search results for Ted Baker in the last five years look pretty underwhelming. Despite large spikes each year around Christmas time, search traffic for the Ted Baker website below has been in decline over the past few years, with a notable muted level of traffic post-coronavirus. Contrast this with higher-end peer Hugo Boss, you can see a much more resilient and consistent level of traffic in the last two years, despite the pandemic.
Ted Baker five year search traffic — Google Trends
Hugo Boss five year search traffic — Google Trends
This shortfall in search traffic likely tells us two things. Firstly, people are searching for Ted Baker less than they normally would. This could be down to the more formal categories familiar to Ted Baker or a sign that there has been a reduction in brand equity. However, on a positive note, it does tell us that Ted Baker’s other traffic drivers to their website are working well, and conversion is also growing, suggesting customer engagement with Ted’s products is also high. This theory can also be referenced in Ted’s recent results, with the image below showing strong growth in engagement for Ted’s digital initiatives.
For a turnaround project such as Ted Baker, I would personally want to focus on the cash flow statement. My main priority would be to seek reassurance on whether Ted has the liquidity to see through the next year of trading, especially as things could still remain tough for its physical retail stores. Looking into Ted’s cash flow statement for the half-year to 2020, you will find Ted in a much better state than the prior-year period. Although Ted Baker made a pre-tax loss during the period, improvements in working capital (efficiencies in employed capital — i.e cost savings for physical stores) allowed for £19 million of free cash flow, meaning there were adequate levels of cash remaining after operating expenditures. As you can see, Ted Baker went one step further and issued new share capital for £105 million and sold their London HQ for £77.8 million in net proceeds, resulting in a healthy net cash flow of £187 million and a net cash balance of £60 million. With the combination of a credit facility and this cash balance, it would suggest Ted Baker has sufficient liquidity to see itself through the next year as the turnaround takes shape.
Whilst this is certainly a positive, we have to be aware that £105 million of this cash balance has been provided by an equity placing underwritten by Ted Baker shareholders rather than being provided organically by the business. Considering Ted’s current market cap is £332 million, it represents a fair chunk of the enterprise value, and the dilution will have definitely affected current shareholders returns. Going forwards this will have a dilutive effect on earnings per share and will provide a drag on returns in the future.
In summary, the years from 2019 have not been kind to Ted Baker; multiple missteps, poor governance and being on the wrong side of trends in their core markets have compounded the bad performance for the company resulting in a steep decline in the shares.
There is a turnaround plan in place that largely covers the biggest issues with the business. This turnaround has room to prosper in digital channels, whilst also showing early signs of good results with strong engagement and conversion from digital advertising. This turnaround also looks to be adequately funded, with improvements in cash balances as a result of the share placing and the sale of HQ.
However, questions over the brand equity of Ted Baker remain, gross margin is still slipping and physical retail outlets will continue to have a questionable future both in light of pandemic restrictions, but also versus a lower cost base online.
Ted Baker reports results on the 10th of June. Here’s what I will be looking for:
Improvement in gross margins
Reassurance of liquidity — has debt position reduced, has Ted retained ample cash balances?
Continued trajectory in growth for the online channel
Closures of non-performing physical locations
Outlook improvement — when does Ted Baker foresee a return to profit?
Signs that the casual/new apparel lines are seeing consumer traction
At the time of writing, The Twenties Trader did not own shares in Ted Baker.
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