Step One Clothing: Back to Square One - Trading update disappoints

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By Alexander Mees

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Head of Research

Date posted:

23 December 2021, 9:00 AM

• Step One Clothing (ASX:STP) disclosed that it had found that it has been overclaiming GST credits in respect of an overseas-based advertising supplier. To rectify this issue, it needs to make an adjustment to prior and current year marketing expenses (-$1.6m in FY22), but despite this, it reaffirmed its prospectus forecast for EBITDA in FY22 of $15m.
• STP also gave a trading update that indicated 1H22 revenue will be up c.12% and in the range $36-38m (MorgansF: $38m). Although group revenue in 1H22 is in line with our prior expectations, STP stated its UK sales grew by only 3% in 1H22, which is disappointingly low for a business in its second full year. The problem was blamed on logistical pressures in the wake of unexpectedly strong volumes during Black Friday.
• STP actually increased its FY22 revenue guidance from 19.9% growth to ’21-25%’, but investors are concerned that the slowdown in the UK makes it less likely that STP will outperform its own guidance. And just like that, STP shares are back to their issue price. We don’t think the story is broken. We don’t think the prospects for growth over the long-term are diminished. We concede the greater uncertainty around the shape of growth in the UK but are mindful not to throw the baby out with the bathwater.
• We have taken a more cautious view on the pace of UK growth and lowered NPAT forecasts in FY23 and FY24 by 3%, but retain an ADD rating. Our updated price target is (login to view)

This is not the upgrade you’re looking for

The GST overclaim uncovered by STP certainly does not reflect well on its financial controls, but assuming the issue is ‘limited to one supplier’ as the company suggests, there is no reason to expect any more material impact on FY22 earnings than the $1.6m pre-tax effect indicated.

Nonetheless, we expect investors to remain wary until the ‘full and detailed GST review’ is completed in 2H22.

For us, the real disappointment in today’s statement was the substantial slowdown in the UK. Having had such a strong first financial year in the UK, decelerating to just 3% yoy growth in 1H22 was a surprise. STP has placed the blame squarely on the logistical pressures experienced with inbound freight and ‘last mile’ delivery after its Black Friday volumes exceeded expectations.

It appears that customers whose deliveries from Black Friday were delayed were in no mood to make follow-up purchases in December. STP’s prospectus forecasts assumed 10% growth in UK sales over the course of FY22 so there is all to do in the second half to make up for lost ground.

Of course any upgrade to FY22F revenue guidance is to be welcomed but many investors will have hoped for more. If sales momentum can be restored in the UK, perhaps risk will continue to be to the upside.

Today’s upgrade is partly (but not wholly) a result of the inclusion of sales of the women’s line that will be launched in January and the sports line that will follow soon after. But everything will depend on whether the core range can resume its previously impressive growth.

Forecast and valuation update

Our FY22F revenue forecast increases by 3% to $76m, within the range implied by company guidance of $75-77m. We have reduced forecast our EBITDA margin to take account of the GST overclaim from 20.3% to 19.8%.

Our EBITDA forecast is effectively unchanged at $15.1m (up 0.3% from $15.0m).

We have lowered FY23F and FY24F NPAT by 3%. This reflects reduced revenue expectations in the UK which lead to a 1.6% lower revenue number in FY23F and 1.4% lower forecast in FY24F. We have also lowered our EBITDA margins by 40 bp and 60 bp respectively to take account of higher marketing and distribution expenses.

Investment view

Our target price falls from (login to view) due to the lower FY23/24 forecasts, lower peer company multiples and a higher asset beta in our DCF.

We don’t think the model is by any means broken and we retain an ADD rating.

Risks

The key risk is that the slowdown in the UK does not reverse and STP is unable to meet or exceed revised guidance. A longer-term risk remains around competitive pressures, especially in the US.

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