Pacific Brands: Research, courage, patience and a bit of luck

We are often asked how our research works in practice and for examples of our philosophy and investment process in action. Pacific Brands is a great case in point. It’s a share that we bought when the wider market view was bleak. We looked past the short-term noise and saw a brighter outlook for the company.

Pacific Brands – the household name you’ve never heard of

You may not be familiar with the name Pacific Brands, but you will almost certainly have heard of its brands. It is a designer, wholesaler and retailer of iconic Australian labels including Bonds, Sheridan, Berlei and Tontine.

Making hay while the sun shines

The years leading up to the global financial crisis (GFC) were a great time for Pacific Brands. Underwear, outerwear, footwear and bedding all went from strength to strength due to consumer spending, a buoyant economy and easy consumer credit. During this period Pacific Brands took on a large amount of debt, which it used for acquisitions. According to the company’s 2007 annual report, the company entered its 2008 financial year with a ‘platform for future growth’ and over A$900m in debt, nearly three times the total value the company reached at its nadir.

When it rains it pours

The wave of good fortune Pacific Brands enjoyed before the GFC suddenly reversed and the company found itself swimming against the tide on all fronts, including:

1. A strengthening Australian dollar and elevated labour costs turned Pacific Brands’ manufacturing facilities from a competitive advantage into a burden.
2. Pacific Brands’ customers (department stores and independent retailers) started to struggle as consumer spending weakened.
3. Fashion swung against Pacific Brands with profitable hosiery sales declining across the industry.

Courage required

The future looked bleak but Pacific Brands took action. In a series of controversial decisions the company shed everything that was non-essential. It moved all manufacturing offshore to focus on design and distribution and discontinued its unprofitable third-tier brands.

But things got worse. A major discount department store stopped selling branded goods and began to sell its own home brands, cutting off a major sales and distribution channel for Pacific Brands.

While many people wrote off Pacific Brands, we saw potential. We believed that Pacific Brands’ products would still find their way to consumers. We first invested in May 2011.

Pressures remained

This was not plain sailing for Pacific Brands, mainly for two reasons:

1. Competition in apparel is fierce and foreign entrants were opening new stores to compete with Pacific Brands
2. The Australian dollar fell, which squeezed profit margins for Pacific Brands.

But Pacific Brands defended well. Its stores were well received; its online stores had some of the highest conversion rates in the industry and the new stores were popular and profitable.

You have to be patient

As you can see from the chart it took us around three years to build our position in Pacific Brands. In 2015 the business then started to show signs of stabilisation. Profits were above expectations and there was growth in its key brands – both in wholesale and retail channels.

Pacific Brands’ share price and the Allan Gray Australia Equity Fund shareholdings

Source: Orbis and Bloomberg

A bit of luck

In April 2016, US underwear company Hanes Brands and Pacific Brands announced that they had reached a deal. Hanes went on to acquire Pacific Brands in July 2016 at $1.15 per share plus a special franked dividend, making the acquisition price effectively $1.19 per share for Australian shareholders of Pacific Brands. Having paid an average of around 65c per share, our investment in Pacific Brands certainly paid off for our investors.

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