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Hellaby Holdings: David Houldsworth

By Jenny Ruth

Saturday 25th February 2006

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 Jenny Ruth
Diversified industrial company Hellaby Holdings shocked the market in October last year when it announced that, based on trading in the three months ended September, it's underlying earnings for the year ending June 30 this year, "may be some 15% below the $20 million achieved last year." The problem was in its retail businesses and Hellaby pointed out that retail "is characteristically cyclical." It didn't say that the September quarter is the least important. Earlier this month, the company was able to modify that warning after an improved second quarter, particularly in the all-important December month. The company said first-half net profit should be about 10% below the $10.3 million achieved in the previous first half. If trading in the second half is similar to that of the second quarter, the full-year result is likely to be between 5% and 10% lower than last year.

Sharechat: Was the BBQ Factory a bad purchase?

Hellaby Holdings managing director David Houldsworth: I don't think so. It's certainly been disappointing, but it's far too early to say it was a bad purchase. There are a number of things that have happened, some of which were beyond our control. It would be incorrect to say it was a good purchase at this point in time, but it is too early to say it was a bad purchase. The reasons behind it are that broadly the outdoor living area has a lot of opportunities in New Zealand. I think, over time, it's going to prove to be a good acquisition.

SC: How much due diligence were you able to do? Some analysts have suggested you were in a competitive process and it was a bit rushed.

DH: There's some truth in that, but quite extensive due diligence was done and we inherited it. The Storefund was going to be a publicly listed company so quite a lot of due diligence was done and we had the benefit of that. It was done professionally by a professional firm.

SC: Did you receive any more information than was in the Storefund prospectus?

DH: We had quite a lot of access to do due diligence ourselves. A lot of the financial due diligence had already been done and didn't need to be re-done, we thought. We certainly had a lot more information than was in the prospectus. Quite extensive work had been done, but the process was somewhat different to that which we would normally undertake. It was a competitive situation and we had a relatively limited period of time to do it.

SC: How did the actual results compare?

DH: Certainly, the results for the first year were disappointing relative the to historic performance of the business.

SC: The more recent historic results had been greatly dependent on a surge in spa sales.

DH: Strangely enough, spa sales are continuing and are a very good part of the business for us. The spa part was something we focused on and had some concerns about. We're the largest seller of spa baths by a country mile in the country.

What are the main reasons why it hasn't performed to your expectations?

DH: In the first year, there were some factors that were outside of our control. The first summer we had was probably one of the worst on record and the barbeque business just didn't happen in December 2004. That had a significant impact on barbeque sales. The other aspect of the business that was projected to grow quite strongly was heating. The following winter, winter 2005, was actually very warm so the heating part of the business didn't occur either. That had a material impact on that year's profit. There were other aspects we should have anticipated. Barbeques are becoming a much more competitive area with the likes of Mitre 10 and Bunnings selling them. We're obviously still going to remain in the lower end and be competitive, but we will pitch it at a higher level which is where we've had quite a lot of success - the niche, up-market end of the barbeque market.

SC: You've also changed the BBQ Factory's management, haven't you and I believe you had problems with the management systems?

DH: We changed management about six or eight months after we bought the business. It was probably just a cultural difference. We wanted to have a more corporate model. Some of the aspects of the management systems weren't producing information we felt comfortable with. The company's undergoing a complete new management information installation. I think it was just a matter of a person who had worked for a private owner for some time and, in the end, he decided he didn't want to be part of a corporate model.

SC: Have you completed your review of BBQ Factory and, if so, are you trying to reposition it? How? Are you still trying to broaden its product categories?

DH: That's an ongoing process. We're certainly not at the end of that by any stretch of the imagination. We've probably made some mistakes over the last season. We probably tried to take it up-market too quickly. We're learning as we go. We are planning to take the business up-market and to cater to the wider outdoor living market with furniture etc, what's called in the industry 'the outdoor room' which is a very strong growing trend internationally and in New Zealand. We believe that area has a lot of opportunities.

SC: Why was Hannahs struggling in the first quarter?

DH: Both Hannahs and Rodd & Gunn, the whole retail market, had a very bad first (September) quarter of the year. You can blame it on various things. People have suggested it might have been because of the election, but July was a terrible month for both businesses. They recovered a lot of that over the ensuing five months. With Hannahs, the winter range wasn't as well-accepted as we though. Certainly, it had a much improved summer season and quite a strong December. It recovered quite a lot of the ground it lost in the first month. Rodd & Gunn had an exceptionally strong December so that bounced back in a big way. That's one of the issues with retail: you've got to get the product right. If you don't, the market tells you, but if you do get it right, it's a very profitable business because the margins in retail are significantly above what you can get in any other business.

SC: Is the Number One Shoe Warehouse cannibalising Hannahs?

DH: I think cannibalising is too strong a word. It would be impossible for the Number One shoe Warehouse's sales to be growing without some of that coming from Hannahs. That would be unrealistic. We figure there's probably about a 10% to 20% cross-over at the margin. The reality is, New Zealand is a relatively low income country and an awful lot of people want a bargain. They're happy to pay a lower price and perhaps recycle their shoes more regularly. Between Hannahs and Number One, we've got a very dominant position in the mid and lower price points of the New Zealand shoe business. That's where the bulk of New Zealand people's incomes are. If someone finds Hannahs too expensive, Number One is sitting there to catch them. With Hannahs, some people are prepared to pay a little more for better quality. If we hadn't bought Number One, it would still have had the same impact but someone else would be benefiting. We thought it was a good way to protect ourselves and take advantage of the growth Number One is experiencing.

SC: What were the key factors in Rodd & Gunn being behind budget last year?

DH: By the end of December, they were in line with budget and quite a bit ahead of last year. Partly it was climatic conditions. There's a rule of thumb that half of Rodd & Gunn's profit is earned in December. It was a combination of bad weather and probably they got some of their product offerings wrong. There's been a change in the design team there about six or nine months ago. The last summer season is the first time the influence of the new team has come into play and the results have been significantly improved.

SC: Is the company too exposed to the retail sector now?

DH: I don't believe so. The reality is, retail is only 35% to 40% of our business and it gets more attention than it deserves. I don't think we would want to have it any more than where it is. Over time, it may decline as a percentage of our total business as we look to grow in other sectors. Hellaby is a company that represents the New Zealand economy and retailers represent a very significant part of the New Zealand economy. I don't have any concerns about retailing as a business. Our shoe businesses are very defensive. At the end of the day, people are going to have to keep on buying shoes. We have such a strong position at the mid to lower end of the market. I'm comfortable with that and I'm comfortable with specialty retailing. I have some concerns about mass-marketing retail. On a longer term basis, I wouldn't want to see retailing as any greater percentage of our group but most products are sold through retail so retail only represents what's going on in the rest of the economy.

SC: How are the company's other divisions faring?

DH: The other divisions are doing very well. Automotive is having a very strong year. Our major company, Brake & Transmission, is quite materially ahead of last year and ahead of budget. Diesel Distributors is growing in Australia. We're looking at expanding into Victoria. We've already got branches in Queensland and New South Wales. The industrial business had a disappointing first quarter as well as some of the other businesses, but that's pulled back in the second quarter and has very strong forward orders. We're very comfortable with the industrial businesses.

SC: How will the declining New Zealand dollar affect the company?

DH: You might think it's going to have a material impact on our company but our margins haven't benefited hugely as the dollar strengthened because all our products are sold competitively against other people. You can't just increase your margins. The price of shoes has fallen as the dollar has strengthened. As long as it's gradual, we don't think it will have a huge impact. We have got cover in place - we cover basically the next season. It doesn't protect you forever. Everybody's going to maintain their margins. Unfortunately, the prices of various products will move up as the dollar declines. Our experience in the past when the New Zealand dollar got down to 40 odd cents against the US dollar, our margins in our main businesses pretty much remained where they were. If the price goes down, you have to sell a lot more to maintain the same sales level so to some extent a lower dollar could be beneficial. I don't think it's going to collapse hugely.

SC: You haven't bought anything (that's been announced) since last July, although you told the AGM you were evaluating a number of potential acquisitions. Does the lack of action reflect capital constraints or has nothing met your criteria?

DH: In 12 months we bought BBQ Factory, Elldex Packaging and the Number One Shoe Warehouse. Two of those three are performing extremely well. We've been looking and are continuing to look at opportunities but we're not in any great hurry. Given the potential direction of the economy over the next two years, we will probably be a little more circumspect at making acquisitions. If there is any downturn, it will create opportunities for us. We're not going to rush in a make acquisitions right now, unless they're extremely attractive. I don't think it (the lack of acquisitions) reflects a capital constraint. It's more to do with things not meeting our criteria. Obviously, addressing the capital issue is something we've mentioned at the AGM. We believe if the acquisition is there, then undoubtedly we would be able to fund it. Our philosophy is if something makes sense you can always find a way to finance it.

SC: Has the experience with the BBQ Factory made you more wary about acquisitions?

DH: I suppose it has. We're not wary to the point where we're not going to do it. There are a number of questions we would ask and probably we would be a little more cautious in some aspects. We've learnt something from it. It's certainly not going to stop us.

SC: Are you likely to seek further capital from shareholders?

DH: We are looking at raising capital. That includes a wide range of possible ways of raising money, one of which is raising equity from shareholders, but there are lots of other ways to achieve it. What we're looking at is what you would call quasi equity, capital notes which is a debt instrument but with a strong equity aspect. I can say quite categorically we're not likely to be raising equity capital from shareholders in the foreseeable future. We will be looking at a capital note or some similar form which is obviously beneficial because it doesn't dilute earnings per share and it's tax deductible and a very efficient way of funding the business. A combination of that and possible divestments will put off any need to raise equity for quite some time.

SC: What areas do you expect further acquisitions to be in? I presume you won't be buying more retail businesses?

DH: I wouldn't say absolutely no more retail but it would need to be very compelling. The only reason we would do it is if we thought it would enhance one of our existing retail businesses. Our focus going forward is going to be on our more core areas of automotive and distribution, those sorts of businesses.

SC: You've mentioned the possibility of further divestments. Are any on the cards at the moment?

DH: Not to the point where I could say we have a process under way. We have clearly identified a couple of businesses that we have interests in that are not core or strategic. We have a 20% holding in New Zealand Wool Services International. We've said that's not core or strategic. At the right time, we will look to exit that. Our 25% shareholding in Energy Intellect isn't considered to be core so we will look at exiting at the right time as well. We have recently concluded a transaction to sell our 75% shareholding in Oakleys Plumbing Supplies, a small Christchurch plumbing supplies merchant. We worked with the management there to enable them to structure a management buyout. That took effect from 31 December. We have, over time, looked to sell down our smaller businesses and I think we've been pretty successful in that. The only other small company that we have an interest in now is Bombay Petfoods which is a very tidy business and does very well. There's no pressure to do anything with that. We've got a good partner. If the right situation came along, we would consider it. We've also go some property interests we're looking at exiting, a few properties we acquired with acquisitions over the last two or three years. We would like to sell some of our industrial properties but there's not a huge amount of money tied up in it - maybe $4 million or $5 million. There could be $15 million to $20 million of divestments.

SC: How will adopting the new IFRS rules affect reported results (less or no amortisation?)?

DH: Amortisation will be the biggest impact. That will be a positive impact because we've written off in the last year about $2.2 million or $2.3 million of goodwill which we won't have to do. We do have this slightly more rigorous regime of looking at the value of the businesses we own or the value of the assets and having to do an impairment test. If any business is deemed to be impaired on a long-term basis, we would have to adjust for that. I don't believe at this point in time there's anything that fits into that category, but it's something the directors will have to keep reviewing. The immediate and ongoing impact will be positive. We have moved from having tax losses available to the group. Last year, our effective tax was 22% or 23% of pre-tax profit. This year, it's going to go up to 23% or 33% so that's going to have quite a negative impact. That was inevitable. It had to happen sooner or later. Our borrowing costs are going to go up this year as well.

SC: You've been managing director for a long time now and you celebrated your 60th birthday last year. Are you considering retiring?

DH: It's true, I've been here eight years and that's a reasonably long time by New Zealand standards. No, I'm enjoying it. As long as things keep going well, I trust I will continue here for the foreseeable future.

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